What Amount Do Retirees Need in an Emergency Fund?

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An emergency fund is essential no matter what your age. But in retirement, not having one can be particularly costly. Having an emergency fund means you don't have to tap your IRA, 401(k), or other taxable assets to pay for unexpected expenses—or worse, go out and get a job. The key to staying on budget as a retiree is to estimate an adequate amount to maintain in an emergency fund and to identify the right type of account to keep it in.

Why Do Retirees Need an Emergency Fund?

Emergency funds are meant to be used for unexpected costs so you don't have to sell off assets or run up debt to cover them. During your working years, an emergency fund is also a source of backup cash if you lose your job or can't work because of a temporary disability.

Heading into retirement, an emergency fund serves additional purposes, including:

  • Protecting long-term investments in case of a market downturn: When the market's down, as can be the case in a recession, withdrawing money from your investment accounts could mean taking a loss. If you have money in emergency savings, you could withdraw that first to give your portfolio time to recover. 
  • Help in covering medical costs: Emergency savings can fill the gaps when it comes to funding medical care. According to Fidelity, a 65-year-old couple retiring in 2020 without employer-provided retiree health coverage might expect to spend $295,000 on health care, not including long-term care. An accident, unexpected diagnosis, or serious illness could result in medical bills piling up if insurance or Medicare doesn't cover the full cost.
  • Easing the loss of a part-time job or spouse’s job: If you supplement your income with a part-time job or your spouse is still working, an emergency fund can provide a temporary income source if that job is lost. 
  • Covering age- or medical-related home improvements: If you’re beset by a mobility issue, you may need to make modifications to your home, such as adding a ramp, installing grab bars in a bathroom, or widening hallways and doors. An emergency fund can keep you from having to drain your pension, 401(k), or IRA to do so.

What Amount Should Retirees Have in an Emergency Fund?

Three to six months' expenses is the rule of thumb for building an emergency fund. The amount you may need as a retiree, though, depends on several factors, including:

  • Your basic monthly expenses, including how much you pay for your mortgage or rent, home maintenance and upkeep, food, utilities, transportation, credit cards and other debts, and health care
  • Your monthly retirement income, including Social Security benefits, pension payments, regular withdrawals from investment or retirement accounts, and annuity income
  • How insulated your portfolio is against risk, in terms of how assets are allocated
  • What you already have available in liquid savings (savings accounts, money market accounts, or CDs)

To approximate a minimum amount for your emergency fund, multiply your total monthly expenses by the number of months you want to cover. For example, if you want a 12-month emergency fund and your monthly expenses are $5,000, you'd need $60,000 earmarked for an emergency savings account.

If the majority of your retirement funds are in cash or other guaranteed investments (not impacted by market downturns), you may not need an emergency fund much larger than the recommended three to six months’ expenses. If, however, a large portion of your retirement funds are invested in securities, like stocks and bonds, a sizable emergency fund is prudent to protect you from withdrawing invested funds when the market is down.

Consider talking to a financial advisor about asset allocation in retirement. Ideally, your portfolio is less exposed to risk once you’ve retired so that you're able to weather market downturns without experiencing significant losses.

Best Places to Keep Your Emergency Fund

Money in a dedicated emergency savings account needs to be available whenever you need it and not be subject to market volatility, liquidity issues, or withdrawal fees. For these reasons, FDIC-insured (or NCUA-insured) accounts are good choices.

High Yield Savings Account

High yield savings accounts offer convenient access to your money while typically earning above-average interest rates on deposits. These accounts can be linked to a checking account for easy transfers and are available at traditional banks, credit unions, and online banks.

Online banks often pay higher rates to savers than traditional banks do, but you may sacrifice branch or ATM access.

Money Market Account

A money market account shares similarities with a savings account—you earn interest on your money, and funds are easy to access. The difference is that some money market accounts also allow you to write checks or withdraw funds using an ATM or debit card.

While savings accounts can sometimes be opened with as little as $1, money market accounts may require a minimum opening deposit of several hundred or several thousand dollars.

Roth Individual Retirement Account

A Roth IRA is used for retirement savings but can also be a good choice to house an emergency fund. As it’s a designated retirement account, you don’t pay tax on any earnings (interest, dividends) within the account. But unlike a traditional IRA or 401(k), you don’t have to pay taxes on qualified withdrawals; contributions can be withdrawn tax- and penalty-free at any time. Moreover, required minimum distributions (RMDs) don't apply during the account owner's lifetime, so there’s no need to start taking RMDs at the traditional RMD starting age of 72 (70.5 if you reached 70.5 before Jan. 1, 2020).

A qualified withdrawal is one you make after you turn 59.5 and after the account has been open for five years. 

Having a savings or money market account in a Roth IRA can be an especially good move if you have, or want to have, a very large emergency fund—one in which interest and dividends could otherwise create an unnecessary tax burden. 

But you can’t make new contributions into a Roth IRA unless you or your spouse are still working (earning income). The annual contribution limit for a couple aged 50 or older with at least one spouse working is $14,000 in 2020 and 2021, which amounts to $6,000 in regular contributions and $1,000 in catch-up contributions for each spouse. And remember: If you open a new Roth account, you need to wait at least five years to withdraw any earnings without being penalized.

Retirees who already have a Roth IRA at one institution (with a broker, for example), but want to allocate some of those funds for emergency savings with another institution (perhaps an online bank offering a higher interest rate) could transfer an amount from the first Roth into a high-interest savings or money market account in a new Roth IRA at the different institution. Funds that are transferred from one Roth to another are not considered new contributions and are not subject to the five-year rule. By doing this, you get the higher savings rate at the new institution without losing the tax benefits of your funds being in a Roth IRA.

If you keep an emergency fund in a Roth IRA, keep it separate from your general retirement funds—in a money market or savings account within a Roth—for emergencies and unforeseen expenses only. Most importantly, you don’t want to invest it in anything that could lose value or be difficult to access, such as a mutual fund (which can lose value), or an annuity with a surrender period and withdrawal penalties.

Where You Shouldn't Keep Emergency Funds

Some accounts aren’t designed for easy and penalty-free access, and therefore are not good choices for an emergency fund. For example, a certificate of deposit account is subject to an early withdrawal penalty for taking money out before the CD matures. This could eliminate most or all of the interest you earn and, in some cases, even cut in to your principal. The same concept applies to annuities with a surrender period as well.

Remember to avoid any account in which your funds aren’t guaranteed. In other words, any type of security, such as mutual funds, stocks, and bonds, are out of the question. Plus, they can have liquidity issues.

A traditional IRA may not be the best choice for emergency savings either, especially if you’re younger than 59.5. You will pay taxes on the entirety of any amount you withdraw, regardless of age. And making an early withdrawal (before 59.5) triggers an additional 10% penalty unless you qualify for an exception, such as total and permanent disability.

When deciding where to keep emergency savings before and during retirement, prioritize accounts that guarantee your money, are penalty-free, and are easily accessible.

Key Takeaways

  • Retirees benefit from having a dedicated emergency fund, even if they have other assets and income streams.
  • Having three to six months' expenses available is only a guideline and may need to be adjusted up for retirees to account for higher health care expenses or increases in everyday living expenses.
  • Emergency funds are best located in savings and deposit accounts that are liquid and easily accessible.
  • Using some retirement assets, such as a traditional IRA or 401(k) for emergencies, could trigger tax consequences.