Emergency Funds in Retirement
Financial planners have long advocated for emergency funds as a cornerstone of financial stability. You've probably heard financial experts suggest having 3-6 months of living expenses set aside. This advice has served many well, providing a crucial buffer against unexpected job loss or major expenses.
As someone transitions into retirement, it's worth revisiting the "why" behind your emergency fund. While there's still a place for an emergency fund for some, it may not carry the same weight it did during your working years. In other words, what worked well during your accumulation years might not be the most efficient strategy moving forward.
Primary Purpose of an Emergency Fund
While refreshing myself for writing this article, I revisited my financial planning curriculum textbooks. Two concepts stood out:
The primary purpose of an emergency account is to cover a large unexpected expense without having to sell other assets at an inopportune time. For example, if your HVAC system breaks and you need $10,000 to replace it, not having enough cash on hand might force you to sell investments in a declining market or sell an extra car when the used car market is low, which is not ideal.
The idea of having 3-6 months' worth of fixed expenses in an emergency fund relates to the notion that one of the worst emergencies a client can face is losing their employment income or becoming disabled. Having three to six months of fixed living expenses provides a better runway to regain employment or adjust your standard of living.
As we consider the place for an emergency fund in retirement, it's interesting that for most retirees, the second point no longer applies. If you're retired, you no longer face the financial risk of job loss and will have other dependable income sources (Social Security, pension, etc.).
The New T+1 Settlement Cycle
Information and data have never moved faster in our world. To keep financial markets evolving with this change, the SEC has been reducing the time it takes to initiate a withdrawal from your investment accounts. This delay between initiating a withdrawal and receiving your funds is called a settlement period. Just a few years ago, the settlement period was T+3. The "T" stands for trade date, and the "+3" meant 3 additional business days. Essentially, you had to wait approximately 4 business days from initiating a withdrawal to seeing those funds in your bank account.
As of May 2024, the new settlement cycle is T+1. I tell my clients if they call in before lunch on Monday, there's a good chance their funds will be on their way to their linked bank account by Tuesday (trade date + 1 business day). I've enjoyed the past year when clients call in for withdrawals, expecting it to take about a week for funds to arrive, and I get to tell them there's a chance those funds will be in their bank the next day.
Will we move to same-day withdrawals in the future? I don't know, but I do think that as more clients experience the 2-business-day turnaround of funds into their bank account, they will feel more comfortable having a lower cash level in their checking account. There are many reasons why you might not be able to wait a week for funds to be delivered from your investment custodian to your bank account. I think there are significantly fewer when the turnaround time is "tomorrow."
Mental Accounting of Money
Another important concept to consider when thinking about emergency funds in retirement is a behavioral bias known as mental accounting. This article on Investopedia highlights some of the challenges investors can unknowingly work their way into:
Why do some people keep a savings jar at home while carrying high-interest credit card debt?
Why do we treat a tax refund from the IRS as "found money" that can be used for a vacation instead of regular income we overpaid to the IRS?
Why do some people have multiple checking accounts to cover different savings goals and spending habits?
For most outsiders, or a financial planner like myself, it can be easy to observe inconsistencies between people's money actions and what they perhaps ought to do (e.g., stop saving in the piggy bank and put all your extra money towards paying off the credit card debt as soon as possible!). This part of my job makes every client conversation a little different, but it is a reminder that our financial life isn't always about optimizing for efficiency or what makes the most sense on paper.
Regarding emergency funds in retirement, it might make you feel a little better to have a large amount of cash in your bank account earning little interest but readily available. Based on your current situation, is that still the best strategy to help you reach your highest priority goals?
Simplifying Your Financial Structure
As we age, I believe trending toward the simplification of your finances can be an excellent goal for many retirees. Some significant items to achieve this might be:
Consolidating the number of investment accounts you have as much as sensible. It's easier to manage your investment plan when you can manage all accounts at one custodian. It's easier to manage beneficiaries, withdrawals, Roth conversions, charitable contributions, and for a spouse to pick things up and keep moving if death or incapacity happens to you.
Go through your house and reduce the number of financial statements you unknowingly have saved. I have clients all the time who have stowed away monthly account statements for years into a drawer and never opened them. Go through those old statements and shred the ones that are no longer applicable. They can be confusing for a beneficiary one day who needs to go through and determine which accounts are still active for mom or dad.
Begin the process of simplifying the number of bank accounts and credit cards you hold. There may have been a time when churning credit cards for points made sense (and maybe you enjoyed doing it!), but you might find your spouse would appreciate things more if there was only one credit card to use, one credit card to pay off, and there wasn't a spreadsheet on your computer of 10 other credit cards open and being actively used to "maintain high credit."
For some couples, especially as they age, this simplification can be more valuable, potentially even more so than maximizing interest on savings.
A Balanced Approach to Emergency Funds in Retirement
To be clear, I'm not on a crusade to eliminate emergency funds in retirement. Rather, I'm encouraging retirees to reconsider whether their current approach still aligns with their needs and goals. Many of our clients have diligently saved more than they'll spend—a testament to good habits! In retirement, it's time to ensure those habits are still serving their current needs, not just carrying forward past practices.
The key is to focus on your overarching financial goals in retirement. Use the concept of an emergency fund not as a rigid rule but as a starting point for discussing how to best manage your money for security, growth, and peace of mind. For some, this might mean maintaining a separate emergency account at your local bank. For others, it could involve a more streamlined approach with fewer accounts.