Do You Need an Emergency Fund in Retirement?

Bob French, CFA

by Bob French, CFA

December 16, 2016

emergency-fund-retirementMost retirees struggle with how to deal with their emergency fund. It’s there to help you deal with, well, emergencies. Retirees are just as prone to emergency as others, if not more so.

You still need a financial reserve to serve as a buffer. While the types of emergencies you need to be prepared for and how you can deal with them has changed, you still need to be prepared for whatever life throws your way.

Retirees Have Different Emergencies

Retirement comes with a whole different set of emergencies compared to your working life, and there’s one big reason that’s true: You aren’t living off your salary anymore. Before retirement, the biggest financial crisis you were likely to contend with was losing your job.

After retirement, that’s not a concern. Most retirees have stopped drawing a paycheck, and you’ve hopefully prepared for that loss of income. Now your other income sources have to step forward.

You still might need a new roof, or help a family member, or deal with a medical issue (this is a lot more likely for retirees). Your emergency fund strategy needs to shift to account for these changes.

Your Emergency Fund Will Look Different

Since the risks are different, your emergency fund should be set up differently. When you were younger, the standard advice was that an emergency fund should be large enough to cover six months of expenses (or some other multiple of three) if you lost your job.

In retirement, you already aren’t working, so it looks a little different. You need to prepare for specific events.

In retirement, your financial reserves will come from four different places:

Cash

It’s always a good idea to have easy access to some cash. Sometimes something comes up and you need to deal with it now. Cash is still your best option in these cases, but it’s only a small piece of your emergency funds.

Home Equity

Using your home equity doesn’t mean you sell your house if something happens to your car – it’s not quite that binary.

You can access your home equity through two main avenues:

Home equity lines of credit are great tools for people who have equity in their home. They’re cheap and easy, giving you quick access to equity in case something happens. And, in many cases, they serve as the second layer of “cash” in a retiree’s emergency fund.

Reverse mortgages are a little bit more difficult to use. There are more rules and costs. Usually, unless you know that you are going to be using the money, you usually want to hold off on getting a reverse mortgage. But simply having the option to use a reverse mortgage and access to that cash is invaluable. Wade Pfau’s book has some pretty invaluable insight into utilizing reverse mortgages in your retirement income plan.

Family and Safety Net

For many retirees, this category is viewed as a last resort. It may be difficult to ask your friends and family for help, but it can be an important fallback option – and it doesn’t need to be financial help. Having someone who can walk the dog or bring over a dinner can be a huge help.

Insurance

I’ve saved the most important piece of your retirement emergency fund for last. Insurance is the backbone of your emergency fund. In fact, it probably has been throughout your life, but you didn’t realize it.

Insurance is there to pay for those large unexpected issues that would (in many cases) cripple you financially. If your house burns down or you have a serious medical emergency, it almost doesn’t matter how many months of income you have in your emergency fund. You will go through that pretty quickly without insurance. But insurance exists to cover such risks.

In retirement, those are the types of risks you are primarily concerned with. For many of the risks that you should worry about, you’ll only need to pay the deductible on your insurance policy.

Depending on your situation, you should consider a couple types of insurance:

  • Health Insurance – This is the big one. Medicare picks up the basics for most retirees, but there may be other things to consider. If you retire early, you will need to sort out your own health coverage until you turn 65. Even if you have Medicare, you may want to consider supplemental coverage.
  • Homeowners Insurance – If you own your home, this is a must – even if you have paid off your mortgage. If you need a new roof or your home gets broken into, you want to make sure you can deal with it. That’s where homeowner’s insurance comes in.
  • Long-Term Care Insurance – This one is tricky. LTC insurance can be an amazing tool – long-term care is incredibly expensive, but not everyone will need it. The problem is, it’s getting harder and harder for people to get – even for younger people. And if you do have it, premiums are rising quickly. That said, it’s something you should at least consider.

There’s always going to be things your insurance doesn’t cover (dental insurance is notoriously picky). That’s why you need to have a multi-pronged emergency fund. Each option can help you with a separate area.

By putting everything together, you’ll be able to survive financial emergencies.

Want to know how your retirement emergency funds stack up? Find out with your own Retirement Income Optimization Map


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