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Why Retirees Really Need an Emergency Fund

By Christy Bieber – Apr 18, 2018 at 2:31PM

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The chances retired Americans will face an extraordinary medical expense over the year are almost double the risk of people in their 20s.

If you're retired, hopefully you have a big 401(k), IRA, or other retirement account to see you through your golden years. While your tax-advantaged retirement accounts will likely hold the bulk of your money, it's also important to have a simple savings account that serves as an emergency fund. 

Emergency funds aren't just for people who are working and raising young families -- seniors need emergency funds too. In fact, retirees may need an emergency fund even more than the average person. Here are four big reasons why it's absolutely imperative you have an emergency fund if you're a retiree. 

Burlap bag full of money

Image source: Getty Images.

1. Costly emergencies may be more likely to hit your household

Emergencies can strike anyone, but unfortunately, seniors may be especially vulnerable to costly issues.

Your elevated risk of emergency could come from an aging home more likely to require repair, as most older homeowners want to stay in their homes as long as possible. If you bought your home in midlife and stay into your senior years, your home may be at the age where costly repairs -- like a new roof -- become necessary. 

And, of course, you're aging too, so your list of possible emergencies includes a major health problem. The chances your household will experience an extraordinary medical payment almost double after age 75, compared to when you were in your 20s and 30s. A major medical payment costs at least $400, is more than 1% of annual income, and is significantly more than normal health spending.

With calamities much more likely to occur, having an emergency fund isn't optional -- it's essential to avoid the serious risk of financial disaster. 

2. Going into debt is a disaster on a fixed income

When an emergency strikes your household, you likely won't have spare cash available to pay for it unless you have an emergency fund. More than 6 in 10 households don't have enough cash to cover emergency costs totaling $1,000 or more, according to a survey from Bankrate. If your household is one of them, an unexpected emergency could leave you in debt.

While debt is always damaging, it can be worse for a senior on a fixed income. Bankrate found average emergency costs totaled at least $2,500, so consider what happens if you put a $2,500 emergency on a credit card at 17% interest.

Minimum payments of around $60 a month would take up 4% of an average $1,404 monthly Social Security benefit -- and it would take 64 months to pay off the balance by paying the minimum. During that time, you'd pay a total of $1,306 in interest. Almost a full month's Social Security benefit would be lost. 

3. You don't want to be forced to pull money out of your retirement accounts

Going into debt is clearly a bad idea, but being forced to pull money out of retirement accounts to respond to an emergency could perhaps be even worse. 

You need to plan withdrawals from retirement savings to make your money last. If forced to unexpectedly make a big withdrawal to cover an emergency, you might deplete your savings too quickly. The money won't be working to earn compound interest for you anymore, and you increase the chances of running out of cash later in life. 

Another reason pulling money out of a retirement account because of a financial emergency could be an issue: Since you can't choose the timing, you could be forced to sell at a bad time, potentially triggering short-term capital gains taxes or taking a big a loss on an investment.

Finally, there's the issue of taxes. Unless you have Roth accounts, money withdrawn from savings is taxed as ordinary income. Still, taxes can be high. If you're in the 22% tax bracket and need $2,500 for an emergency, you may actually need to withdraw around $3,200 to afford $704 in taxes and still have the money to cover your costs.

And, in a worst-case scenario, your withdrawal could push your total income above the threshold below which Social Security benefits aren't taxed. You could end up taxed on 50% to 85% of benefits, depending on how high your taxable income ends up being.

4. You may not be able to work extra to make up for financial disaster

While younger people who get into debt or face unexpected financial disaster can often pick up some overtime or start a side hustle, options may be more limited for a senior.

Age discrimination and being out of the workforce for a while could make getting hired difficult or impossible, and physical limitations may prevent you from even trying to work. If you cannot increase your income, going into debt or making unplanned and costly withdrawals could be a true financial calamity from which you don't ever fully recover. 

How much should you have in your emergency fund?

While those who are still working are typically advised to set aside three to six months of living expenses in case of a job loss or other emergency, seniors usually don't have to worry about losing income -- it's unexpected expenses that create the biggest issue. 

The size of your emergency fund should be based on a personalized assessment of risk factors. For instance, if you're a renter with no car, great health, and comprehensive supplemental insurance, you may need only a small emergency fund.

But most seniors would be wise to err on the side of saving a more substantial sum. With a larger cash cushion, if a health issue or another big problem strikes, you won't have to worry about the calamity ruining your finances for the rest of retirement. 

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