Regardless of what you call it: nest egg, rainy day fund, mad money, reserve fund, back-up, stash, cache, emergency funds, piggy bank, or simply ‘your savings’, the fact is that a majority of baby boomers don’t have funds set aside to cover the cost of even a small emergency. Instead they must make a withdrawal from one of their retirement accounts. What’s wrong with that you might ask? Well, unplanned withdrawals from your retirement accounts might bring additional tax liabilities, penalties or both. Ouch.
Obviously, baby boomers depend significantly on their retirement funds in retirement along with their Social Security and pension income. However, they seemingly forgot the plan they instituted in their youth and no longer maintain a contingency fund containing at least three months’ worth of expenses which is set aside for emergencies. While it can be more difficult to save with the reduction in income most retirees experience, it is both possible and important to maintain an emergency fund that does not require you to sell stocks and bonds at a loss or pull from an individual retirement account, all of which could result in a requirement to pay more in taxes than you had budgeted for the year (or indeed included in your quarterly tax payments).
An emergency fund is a good idea at every stage of an adult's life, but why is it even more important in retirement? Once you’re retired, you’re typically living off of savings and fixed income from investments and Social Security—not a salary. And, as individuals age, their typical annual expenses for health care usually go up because the risk of disease or injury can be higher.
Do Baby Boomers need an emergency fund in addition to their retirement savings? While you don’t need to have an emergency fund in a separate bank account than your savings, depending on your own ability to budget, it could be a good idea. The recommended amount of money in an emergency fund is based on a person's current and projected cost of living, but a good rule of thumb is about six to 12 months of average living expenses—and the more the better.
What needs to go into creating and maintaining an emergency fund? Take a look your current insurance coverage—including life and health insurance—as well as your average monthly burn rate (or your total monthly cost of living). Next, list any dependents you’re currently assisting or may need to help in the future—like children, grandchildren or friends. Also consider your current health and any existing conditions, the anticipated increase in health insurance costs and the future costs of estate planning—as well as any senior services that may be required like assisted living, skilled nursing, home healthcare and hospice.
When should you use an IRA for those unforeseen emergency expenses in retirement? You should have a good idea of your liquid assets, outstanding debt and any equity you have in real estate or traded securities. IRAs and 401(k)s can be solid backups to emergency fund accounts, but they can take longer to liquidate, so the proceeds may not be readily available in an emergency. Don’t rely on them heavily for your emergency funds.
Saving specifically for an emergency will ultimately protect your retirement planning.
Reference: Fox Business (August 14, 2016) “What Nest Egg? Two-Thirds of Americans Can't Cover $1,000 Emergency”