For a Sunny Retirement, Have a Rainy-Day Fund

Do you remember, when you were a kid, how much more fun it was to play goalie in a pickup soccer game if you actually had a net behind you? You didn’t have to scramble nearly as much when your opponent surprised you and the ball blew past. The net caught it for you.

That’s kind of how it is with a rainy-day fund. You can probably get by in retirement without one, but you could be left scrambling when unexpected expenses come up.

And for most, they will come up. Maybe you’ll need to replace your old roof, your old car or your old AC unit. Perhaps you’ll want to give your daughter the funds to start her own business. Or you might decide to help your son put a down payment on a new house after he gets a divorce.

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The emergency fund you should have had when you were younger can be just as critical when you’re older. Maybe more so, because you won’t have a regular paycheck to depend on anymore.

But what I’m seeing fairly frequently these days is that even the best savers – those who diligently contribute to their 401(k) plan every month, the maximum allowed or at least to the company match – aren’t necessarily accumulating liquid assets they can easily tap into when they need extra money.

As they head for retirement, they may be in for an expensive surprise. If they choose to pull out a chunk of their tax-deferred money to pay for those unplanned costs, it could have a ripple effect they didn’t expect.

Let’s say a frugal saver who has a robust 401(k) needs a new car, and the one she chooses costs $35,000. She doesn’t want to take out a loan, so she decides to take the money from her retirement savings. What’s the harm, she asks herself; she’s over 59½, so there’s no extra penalty.

No, but there are still consequences. Because she hasn’t already paid taxes on that money, she’ll have to pay taxes on those withdrawals as though it were ordinary income. To buy that $35,000 car with her 401(k) funds, she’ll have to take out an extra 20% to 30% to cover the taxes. And if the market is down when she withdraws the money, it could have an even more significant long-term impact.

The usual recommendation is to have enough in an emergency fund to cover at least six months’ worth of expenses in case you can’t work or you lose your job. In retirement, though, it’s a little different. You’ll have Social Security, your pension (possibly) and other income streams to cover day-to-day costs. Your savings will be for extra needs and wants. You may wish to sit down and think in terms of potential emergency situations to arrive at a reasonable amount. Or you can keep it simple and sock away a lump sum of $50,000, $100,000 or more, based on your lifestyle or any big expenses you might see coming down the road.

You’ll also want to stay disciplined about replenishing that rainy-day fund and work it into your overall retirement plan.

I often advise clients who expect to retire in two to three years – who still have good cash flow from working at their job but are winding things down – to contribute just enough to their 401(k) to get their employer’s matching contribution and shift the rest to a savings or money market account to build up a cash reserve. They may even decide to stop their contributions altogether.

It isn’t easy to move money from an account that’s earning money to one that pays almost nothing – I get that. You’ll need some money immediately accessible in cash at your bank, but consider keeping the remainder of your emergency savings in money market funds or a money market account. These earn interest, are easy to liquidate and come with low or no penalties for withdrawals.

The important thing is we want to make sure there’s some emergency money available, because even if you’re debt-free, one big bill could have a significant impact on your retirement plan. Ultimately, your emergency fund is to protect your income-producing investments, and the more you have in your retirement rainy-day fund, the less likely you’ll need to tap your investments.

Financial professionals talk a lot about the importance of proper asset allocation when deciding in which financial vehicles to put your retirement money. But this simple but vital asset – money set aside for liquidity and enjoyment – is often overlooked. Talk to your financial professional about how and when you should build a cash reserve into your plan.

Kim Franke-Folstad contributed to this article.