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Q: I am in my eighth year of retirement. A few years in, I found myself spending a considerable amount on repairs and upkeep on my old house. I also had to replace my car. Luckily, I was able to build up a reserve fund to cover costs so I didn’t have to dip into my investments for these “life happens” events. What is your advice on how much cash a retiree should have on hand to feel secure? – Karen Hendershot
A: Of course, everyone should have a cash cushion to handle unexpected expenses, but retirees need a larger cash reserve than people who are still working, says Richard Paul, president of Richard W. Paul and Associates in Novi, Mich. “The stakes are higher for retirees,” Paul says. “When you’re no longer earning an income, the money you have saved isn’t easily replaced.”
If you need to tap your investments for emergencies, you risk spending down your portfolio too quickly. And if you have to sell securities in a down market, you’ll need to take a bigger chunk to get the amount you need.
Relying on your investments for unexpected expenses could also trigger some nasty tax consequences. If you liquidate money from a taxable account, the income could bump you into a higher tax bracket and cost you even more.
So, how much do you need? While the standard recommendation is to have six to 12 months of money set aside to cover emergencies, retirees should have at least 12 to 18 months of cash, says Paul. That should be enough to cover daily expenses as well as any emergencies that might crop up. “This creates a safety valve, so you’re not at the whims of the market,” he says. Use an interactive worksheet like this one from Vanguard to tally up your monthly expenses.
Exactly how much you will need depends on your individual circumstances. If you have guaranteed cash flow, say from a pension and Social Security, that covers your daily expenses, you won’t need to have as much set aside as someone who is already withdrawing money from a portfolio to cover living costs. You can’t foresee emergencies but you can plan for them. If you have an older home, for example, you can anticipate needed repairs or upgrades like a new roof. If you have any medical issues, you’ll want to keep a larger stash for medical costs. “Medicare doesn’t cover everything,” Paul notes.
Since people tend to enter retirement with most of their money tied up in investments, such as 401(k)s and IRAs, Paul recommends that you start building up an emergency fund before you retire. While you’re still earning, start funneling money into a savings account and move a portion of an IRA into a short-term bond fund.
On the flip side, you don’t want to keep too much of your savings in cash. You won’t earn much interest in a money market fund or basic savings account, so balance that cash cushion with investments that can keep up with inflation. “You still need your money to grow,” Paul says.