Retirees lack emergency savings to cover yearly unexpected expenses
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When calculating how much income you’ll need to pay for living expenses in retirement, remember to consider: How you will cover unexpected costs.
More than 8 in 10 retiree households (83%) will face unplanned expenses in any given year, report finds new research Dr. from Boston College Center for Retirement Research. Among households facing unexpected expenses, the average annual amount spent during retirement is $6,000. In other words, the average household will spend an amount equivalent to 10% of its annual income.
However, according to the research, many households do not have emergency savings. About 58 percent have enough cash to cover unplanned expenses for a single year, while about 16 percent will have to use 401(k) or other retirement accounts and the remaining 27 percent will fall short even after using all their cash and retirement assets.
“About 40 percent [retired] Households do not have enough money to cover even one year [of unplanned expenses]let alone all their retirement,” the study notes.
The research uses data from 3,427 retiree households that are part of the 2000-2020 Health and Retirement Survey and the Consumption and Activities Mail Survey, both from the University of Michigan.
Saving some cash is important
While experts generally recommend that non-retirees set aside three to six months of living expenses as emergency savings in case of job loss or other financial shocks, that amount may look different for retirees who must figure out how to stretch their savings over a decades-long retirement.
Like many retirees Struggling to keep up with prices that continue to rise while accounting for unexpected expenses is an important part of assessing whether you’re ready for retirement.
“This helps you plan for liquidity against your income needs,” said Anqi Chen, associate director of savings and household finance at the Center for Retirement Research and co-author of the report.
Some households may struggle to set money aside, but “even small amounts of savings will help provide some sort of buffer when these events occur,” Chen said.
In the research, expenses are divided into three categories:
- “Rainy day” expenses, such as car maintenance over $500 or home maintenance over $1,000.
- Family-related expenses, such as the death of a spouse or providing financial assistance to the family.
- Medical expenses over $500, such as dental expenses or prescription costs.
The Center for Retirement Research estimates that 60% of all retired households will experience a rainy day shock; 29% will have an unexpected family-related expense; and 58% will face an unexpected healthcare expense.
According to the research, high-income retirees experience these unexpected expenses more than low-income retirees. For example, about 45% of households with incomes under $50,000 experience a rainy day or health care shock in a given year, compared with 80% of those with incomes of $100,000 or more.
“This finding highlights the fact that households have some control over when and how much they spend,” the report states.
Think in terms of ‘access to cash for surprises’
So how much would you have to allocate? Depending on the retiree’s individual situation, financial advisors may recommend anything from three or six months of spending to several years or some variation of these parameters. Much of this will depend on your personal situation.
“We often tell our clients to think less in terms of months of expenses and more in terms of access to cash for surprises like health care expenses, home repairs or family needs,” said certified financial planner Joon Um, a tax advisor at Secure Tax and Accounting in Beverly Hills, Calif.
“For many retirees, that means a year of basic expenses adjusted for guaranteed income, like Social Security or a pension,” Um said.
Um said the right amount depends on how flexible your health, housing, income stability and other assets are.
“Retirees with fixed income and liquid portfolios may need less cash, while those with higher medical risk or less flexibility may need more cash,” Um said. “The goal is not to maximize cash. It’s to have enough cash to prevent long-term investments from being sold at the wrong time.”
In other words, if you don’t have enough money set aside, you may find yourself in a position to sell investments when the market declines.
Avoid having too much cash
However, he is a chartered financial analyst and CFP and St. Having too much cash comes with its own risks, said Peter Lazaroff, chief investment officer at Plancorp in St. Louis.
“If a retiree has more than two years of spending in cash, that’s too much,” Lazaroff said. “From a purely mathematical standpoint, you’re giving up too much of the return.”
He said the biggest risk to your cash is inflation. The latest reading of the consumer price index showed that the annual inflation rate in December was 2.7%.
“Your cash becomes less valuable every year,” he said. “You are risking your purchasing power.”
He recommends keeping your cash in a high-yield savings account; This account currently generally yields more than 3% interest. According to Bankrate — To help minimize the impact of inflation.
