A financial writer at Morningstar recently published an article about how to manage unplanned expenses in retirement. For the most part, the article contained a summary of comments submitted by readers of a Morningstar discussion board. I found the topic to be quite interesting because of the different philosophical approaches taken by different retirees to the “emergency fund” problem. I have some thoughts of my own about these issues.
A second category of extraordinary expenses that may not be true “emergencies” are costs associated with risks that can be insured against. Fires, accidents, illnesses, etc. may be unusual but their consequences can be so devastating that having insurance is critical. If you are still working for needed income, disability insurance should be procured. Health insurance should be purchased to cover losses that you cannot self-insure. The wild card for older folks is long term care insurance, i.e., do you purchase it or take a risk and self-insure? This requires careful thought and analysis.
This leaves the “emergencies” that cannot reasonably be anticipated or insured against. Eamples may include uninsurable damage caused by flood or other “act of God”, a temporary job loss, or helping a family member in dire financial straits. How do you prepare for those?
The conventional answer is having an “emergency fund.” OK- but what should that look like? How much should be in a retirement emergency fund and where should it be kept?
A first requirement should be liquidity and easy access. Money in a bank savings or interest checking account is the classic example. This should be a separate account, dedicated exclusively to non-recurring, unusual expenses. As some commenters noted, you don’t want to go overboard with this emergency fund account. Instead, build it up to a comfortable level and then periodically skim the excess funds away to spend on something fun. In other words, reward yourself for being diligent in your emergency preparations.
One commenter stated that he used a HELOC as his emergency fund. I wouldn’t want to rely on credit as a first line of defense against financial emergencies. On the other hand, having HELOC funds available as a double-emergency back-up is an excellent idea, as long as you are not paying fees to maintain it.
It is probably true – as one commenter stated – that many retirees with significant retirement portfolios do not really need an “emergency fund.” If something comes up, they can just sell more investments to cover it. I have two concerns about this approach. First, if your retirement income plan is fundamentally based on calculated, scheduled withdrawals from your retirement investments, using those same investments for financial emergencies may derail your plan. This would be particularly the case if an emergency forced you to sell stocks, etc. during a down market.
Second, having a dedicated emergency fund can bring peace of mind to a retiree. There is a lot to be said for having peace of mind as you age.
Our current plan for an emergency fund is to maintain significant cash reserves in a rewards checking account that is currently paying interest at almost 3%. While this account is also used for our monthly expenses, we always keep the balance above our cash flow needs to capture maximum earned interest.
Our checking account reserves are backed up by an online savings account and by a collection of I-Bonds which can be redeemed in a day if necessary. For any uninsured medical emergencies, we have built up a significant balance in our Health Savings Account by investing instead HSA funds instead of using them to pay routine medical expenses.
So what are your plans for dealing with financial emergencies in retirement?
Here is the link to the full Morningstar article.