Invested Retirees Need an Emergency Fund, Too

The usual reason for keeping an emergency fund is simple: If you lose your job, you still need money to pay the bills.

That changes in retirement.

Social Security, pensions, and annuity payments may continue arriving even when there is no paycheck to replace. But financial advisers still say retirees need a cash cushion.

It just serves a different purpose.

For retirees, an emergency fund can help protect an investment portfolio.

A major home repair, a replacement vehicle, or a large out-of-pocket medical bill can create the need for cash at exactly the wrong time. If the stock market is down, selling investments to cover the expense can lock in losses.

Fidelity notes that selling during a market decline can also reduce the pool of money a retiree depends on for future income.

Taking a large withdrawal from a traditional IRA can create another problem. Because those withdrawals are generally taxable, pulling out more than planned in a single year can increase a retiree’s tax bill.

That is why some financial planners recommend a larger cash reserve for retirees than the familiar three- to six-month emergency fund often suggested for working households.

Depending on a retiree’s income sources, expenses, and investment mix, some planners suggest keeping closer to one or two years of essential expenses in cash or other highly liquid holdings.

The idea is not to avoid investments. It is to create enough breathing room so a market downturn does not force a sale at an unfavorable time.

But there is also a downside to holding too much cash.

Fidelity cautions that cash can lose purchasing power to inflation over time. And if the money was withdrawn from a tax-deferred retirement account unnecessarily, the withdrawal may have created a tax bill without providing much benefit.

That means the goal is balance.

A retiree with steady income, low expenses, and a conservative portfolio may need less cash than someone who depends heavily on investment withdrawals. Large upcoming expenses, health needs, and housing costs can also change the calculation.

And an emergency fund is not designed to cover every possible crisis.

A truly catastrophic expense may still require selling investments, using home equity or making other financial moves, preferably with professional guidance.

The emergency fund is there for the surprises in between — large enough to keep an unexpected bill from forcing a bad investment decision, but not so large that too much money sits idle.