Preparing for the Unexpected: Building and Maintaining an Emergency Fund in Retirement

You've worked hard, saved diligently, and now you're enjoying your well-earned retirement. But even in retirement, life can throw curveballs. An unexpected home repair, a sudden medical expense, or even a once-in-a-lifetime opportunity can strain your carefully planned budget. That's where an emergency fund comes in.
As a financial advisor, building a war chest containing an emergency fund and high-quality short duration bonds in a diversified investment portfolio is something I help my clients with on a regular basis.
Let's explore why you need an emergency fund and how to build and maintain it effectively.
Why You Need an Emergency Fund in Retirement
You might be thinking, "I'm retired. I've already saved. Why do I need an emergency fund?" Here's why:

1. Fixed Income Reality: Many retirees live on a fixed income from pensions, Social Security, and retirement account distributions [1].
2. Market Volatility: Unexpected expenses during market downturns can force you to sell investments at inopportune times [2].
3. Health Uncertainties: Medical emergencies can be costly, even with Medicare coverage [3].
4. Home and Auto Repairs: Major home or vehicle repairs don't stop in retirement.
5. Family Needs: You might want to help family members in financial distress.

An emergency fund provides a buffer against these unexpected costs, helping you maintain your financial stability and peace of mind.
How Much Should You Have in Your Retirement Emergency Fund?
While working, the general rule of thumb is 3-6 months of expenses in an emergency fund. In retirement, you might want to take a different approach:
General Guidelines:
For those near retirement or in retirement, having approximately 7 years of expenses in high quality, short duration bonds in your investment portfolio will provide a war chest to draw upon.
The exact dollar amount that you have saved up is going to be very dependent on your unique situation.
Example:

• $75,000 in annual living expenses
• $55,000 in fixed income (pension/social security)
• $500,000 investment portfolio
• $20,000 annual portfolio withdrawal needs

In this case, I would suggest having $140,000 in high quality, short duration bonds and the remaining amount ($360,000) in a diversified equity portfolio.
Factors to Consider:

• Your monthly expenses
• Health status and insurance coverage
• Home and auto condition
• Family obligations

Remember, these are guidelines. Your specific needs may vary.
Building Your Emergency Fund: Strategies for Retirees
If you're starting from scratch or looking to boost your emergency savings, here are some strategies:
1. Start Small, But Start Now
Even small, regular contributions can add up over time.
Action Step: Set up an automatic transfer of $50 or $100 per month to your emergency fund.
2. Reassess Your Budget
Look for areas where you can trim expenses to redirect money to your emergency fund.
Pro Tip: Review subscriptions and memberships. You might find services you no longer use or need.
3. Consider Part-Time Work
A part-time job can provide extra income to build your emergency fund while keeping you active and engaged.
Idea: Look for flexible, enjoyable work that aligns with your interests and skills.
4. Use Windfalls Wisely
Dedicate a portion of any windfalls – like tax refunds or inheritances – to your emergency fund.
Rule of Thumb: Consider allocating 50% of windfalls to your emergency fund until you reach your goal.
5. Optimize Your Retirement Account Withdrawals
If you're taking required minimum distributions (RMDs), consider setting aside a portion for your emergency fund.
Strategy: If your RMD is more than you need for expenses, direct the excess to your taxable brokerage account.
Where to Keep Your Emergency Fund
Your emergency fund should be easily accessible but not so accessible that you're tempted to dip into it for non-emergencies.
Good Options:

1. High-Yield Savings Account: Offers better interest rates than traditional savings accounts while maintaining liquidity [4].
2. Taxable Brokerage Account: Taxable accounts provide significant flexibility and investment options. Be sure to choose investments that are aligned with your cash flow needs.
3. Money Market Account: Often provides check-writing privileges for easy access when needed [5].
4. Short-Term CD Ladder: Can offer higher yields while still providing regular access to funds [6].

Avoid:

• Keeping large sums in low-interest checking accounts
• Investing emergency funds in stocks or long-term bonds

Maintaining Your Emergency Fund in Retirement
Once you've built your emergency fund, maintaining it is crucial. Here's how:
1. Regular Reviews
Review your emergency fund at least annually to ensure it still meets your needs.
Checklist:

• Has your monthly spending changed?
• Have you experienced any health changes?
• Are there any upcoming large expenses?

2. Replenish After Use
If you dip into your emergency fund, make a plan to replenish it.
Strategy: Temporarily reduce discretionary spending or consider taking a larger distribution from retirement accounts (if feasible, but keep in mind tax consequences) to rebuild your fund.
3. Adjust for Inflation
The purchasing power of your emergency fund can erode over time due to inflation.
Action Step: Increase your emergency fund balance by 2-3% annually to keep pace with inflation.
4. Balance with Other Financial Goals
While important, your emergency fund shouldn't come at the expense of other financial priorities.
Consider: Balance building your emergency fund with other goals like charitable giving or legacy planning.
Tapping Your Emergency Fund: When and How
Knowing when to use your emergency fund is as important as having one. Here are some guidelines:
Appropriate Uses:

• Unexpected medical expenses not covered by insurance
• Major home or auto repairs
• Family emergencies

Not for:

• Regular bills or expected expenses
• Discretionary purchases
• Loans to family or friends

Decision Framework: Before using your emergency fund, ask:

1. Is this expense truly unexpected?
2. Is it urgent?
3. Are there other ways to cover this cost?

Special Considerations for Washington State Retirees
As a Washington state retiree, you have some unique factors to consider:

1. No State Income Tax: This can make budgeting more straightforward, but remember that you'll still have federal taxes to consider [7].
2. Property Tax Exemptions: If you're 61 or older, you might qualify for property tax exemptions, potentially reducing your emergency fund needs [8].
3. Long-Term Care Benefit: Washington's long-term care benefit (WA Cares Fund) may reduce some future emergency expenses, but it's not a complete solution [9].
4. Climate Considerations: Washington's diverse climate means preparing for various emergencies, from wildfires to floods. Factor this into your emergency fund planning [10].

Your Emergency Fund Action Plan
Ready to build or optimize your retirement emergency fund? Here's your action plan:

1. Assess Your Needs: Calculate your monthly expenses and determine your emergency fund target.
2. Review Your Current Savings: Identify how much you already have set aside for emergencies.
3. Set a Savings Goal: If you're short of your target, set a realistic goal to build your fund over time.
4. Choose Your Account: Select a high-yield savings account or other appropriate vehicle for your emergency fund.
5. Automate Contributions: Set up automatic transfers to your emergency fund.
6. Review Insurance Coverage: Ensure you have adequate health, home, and auto insurance to reduce potential emergency expenses.
7. Create a Fund Use Policy: Establish clear guidelines for when and how you'll use your emergency fund.
8. Plan for Replenishment: Develop a strategy to rebuild your fund after using it.
9. Annual Review: Set a yearly date to review and adjust your emergency fund.
10. Stay Informed: Keep up with changes in local laws, benefits, and resources that might affect your emergency planning.

Remember, an emergency fund is more than just a savings account – it's your financial safety net in retirement. By building and maintaining a robust emergency fund, you're not just preparing for the unexpected; you're investing in your peace of mind and financial security.
Sources:

1. Social Security Administration, "Understanding the Benefits," 2024.
2. U.S. Securities and Exchange Commission, "Saving and Investing for Retirement," 2024.
3. Medicare.gov, "What Medicare Covers," 2024.
4. Federal Deposit Insurance Corporation, "Weekly National Rates and Rate Caps," 2024.
5. Consumer Financial Protection Bureau, "What is a money market account?," 2024.
6. Financial Industry Regulatory Authority, "Certificates of Deposit (CDs)," 2024.
7. Washington State Department of Revenue, "Taxes and Rates," 2024.
8. Washington State Department of Revenue, "Property Tax Exemptions," 2024.
9. Washington State DSHS, "WA Cares Fund," 2024.
10. Washington Emergency Management Division, "Hazards," 2024.
11. Consumer Financial Protection Bureau, "What is a home equity line of credit?," 2024.
12. National Association of Insurance Commissioners, "Life Insurance," 2024.
13. U.S. Department of Housing and Urban Development, "Home Equity Conversion Mortgages for Seniors," 2024.

 

-Seth Deal