Will you still need an emergency fund when you retire? The answer, surprisingly, is YES. But it won’t necessarily function the way it did during your working years.

Emergency funds for the employed are mainly there to cover a disruption in wages or drastic drop in your household income. After retirement, you won’t have wages, and one hopes you’re ready to live on less income, if necessary. But that doesn’t mean you don’t need to prepare for contingencies and the unexpected expenses that can impact your budget – and even your investment portfolio. In a sense, you could say that, in a retirement emergency fund, the purpose shifts from covering lost income to protecting assets.

What kind of situations might arise in retirement that would require an emergency fund?

For a Bear Market

Most retirees live at least partially on income earned on their investments, and that generally involves periodic distributions from retirement fund accounts. No account, even if invested conservatively, is immune from jolts in the financial markets.

If your withdrawals require the liquidation of assets, they may result in forced selling at inopportune times, causing losses. You don’t want to make a habit of it, but an emergency fund can be used to avoid selling investments during a severe bear market at the worst possible time.

For Household Disasters

Alas, surprise disasters with your home, your car and nearly every other possession don’t stop when you retire. Once again, an emergency fund can help put out short-term fires. Insurance, after all, doesn’t always pay as quickly as we need it to, and if you don’t have a cash cushion, you’ll be high and dry until the next benefits check arrives.

For the ‘Boomerang Kids’

You’ll probably want to pad your emergency fund with extra cash to handle contingencies for your kids, even if they’re grown. Many adult children return home to live, or face any number of difficulties that they aren’t financially prepared for.

A few thousand dollars extra to cover come what may with your children may prove to be a necessary addition to your emergency fund. Should a crisis develop, you’ll be able to handle it without needing to liquidate your investments.

For Health Insurance

Health costs only magnify with age and need to be prepared for. If you’re 65 or older, of course, you’ve enrolled in Medicare. While it’s still the best healthcare deal around, Medicare is evolving and generally covers less than it once did. To make up for the difference, retirees have the option to buy supplemental coverage to handle much of what Medicare won’t.

What if you’re joining the millions of people who are retiring before the traditional Medicare-eligible age of 65, when Medicare and its supplements kick in? Unless you are lucky enough to have certain other options (see below), you’re probably having to rely on private insurance coverage. Most large insurance companies offer individual health insurance plans; the drawbacks are that they can refuse coverage for health reasons or they can charge you higher premiums if they do accept you (especially given your age).

All of this creates a real need for an emergency fund to pay for expenses not covered by health insurance. In addition to their premiums, all health insurance plans have deductibles and co-insurance provisions.

Deductibles represent a sum you must incur in medical expenses before your health insurance will kick in. That means you, the insured, must pay out-of-pocket the first $1,000 or $3,000 or $5,000 (depending on the level of your deductible) of your doctors’ bills.

Even when your deductible has been met and your coverage begins to take effect, the insurance company “shares” costs with you through co-insurance. The co-insurance provision may require you to pay, say 20% of any expenses beyond your deductible, while the insurer pays the remaining 80%. In most cases, the co-insurance provision will terminate at a fixed point, say $10,000, beyond which the insurer will pay 100% of any covered expenses.

The takeaway here is that you will have a deductible and a co-insurance provision that you’ll need to be prepared to cover. And whatever that total is for you, you will need to double it if your spouse is on your policy. Let’s say you have a $3,000 deductible, plus an 80/20 co-insurance provision, up to $10,000 (the insurer pays 80%, you pay 20%, or up to $2,000); Your maximum exposure for healthcare costs will be $5,000 (the $3,000 deductible, plus up to $2,000 on the co-insurance). Your spouse will have an equal exposure, for a total of $10,000 for you both. That’s the least that  should be in your emergency fund, to avoid having to dip into investment capital.A jar full of cash used as an emergency fund.

Other Health Insurance Options for Retirees

Because medical costs can be so high, it behooves non-Medicare eligible retirees to look into options other than private, individual plans. These can include:

Employer Health Plans

The first, best choice is to continue on your last employer’s health insurance. Due to cost, relatively few employers offer health coverage for retirees anymore. If you’re lucky enough to work for one that does, you’ll have the following advantages:

  • The plan will cover you regardless of your health.
  • Your premiums will be the same as those set for every other member of the group, meaning you won’t pay more than others even if you have health issues.
  • Your coverage can’t be canceled except for non-payment of premiums.
  • Your former employer may pay some or all of the premium.

When you leave an employer who has group health insurance coverage, the employer must make continued coverage available to you under the federally mandated Consolidated Omnibus Budget Reconciliation Act, more commonly known as COBRA. This can be the next best thing to employer retiree health insurance, since most of the advantages listed above work here, too. But there are two limitations and they’re big ones.

Under COBRA, you must pay the full premium of the company plan. There will be no employer subsidy, and the plan administrator can add an administrative fee on top of that. Translation: COBRA isn’t cheap! It might well be double or triple the monthly premium you paid when you were employed. On the plus side, its premiums can count as deductible medical expenses on your federal income tax return (unlike in your employment days).

The second major limitation is that COBRA plans are temporary. They generally run for up to 18 months after job termination (36 months in some states, such as New York), and can be extended up to 29 months in the event of certain disabilities. COBRA plans are best used by people who are either retiring no more than 18 months prior to being Medicare-eligible, or as a temporary plan until more permanent coverage can be obtained.

Part-time Jobs

It might be worth it to rejoin the rat race, at least for a lap or two, since some companies offer health insurance coverage to their part-time employees. Starbucks, WalMart and UPS are some of the biggest, but many banks and large department stores do as well.

Also look into federal, state and municipal government jobs. The plans may not include an employer subsidy on the premium, but they will be group plans, offering all of the advantages that group plans do.

How Large Should a Retirement Emergency Fund Be?

It will never be an exact science, but your retirement emergency fund should include, at minimum, the annual premiums, deductibles and co-insurance provisions for all your major insurance policies: health, auto and homeowners. The more kids you have, the more you should have in your emergency fund, in case you have to cover their contingencies as well as your own.

After that, it comes down to how much of a cushion you feel comfortable having—and, of course, can afford to put there.

Should You Put that Emergency Money in Your Roth IRA?

One thing you probably shouldn’t do: Use your emergency money to fund a Roth IRA. First of all, that money should be for the proverbial rainy day, not for investment. But also, it just isn’t a good financial move. Sure, if a thunderstorm breaks over your head, you can take out money from the Roth and then you can return it—kind of.

For starters, remember that you can only fund a Roth IRA with employment income—say, from a part-time retirement job. The good news is that, unlike with a Traditional IRA, you can keep funding your Roth after age 70½. So if you have employment income, you can return money to your Roth. How much you withdraw is also an issue in what you can return.

If you put in $6,500 on January 1st (we’re assuming you’re age 50 or over—otherwise the max is $5,500), you could withdraw it during that tax year at any point without penalty or taxes. Let’s say you withdraw the funds on August 1st. You now have until April 15th of the next year (the end of your current year tax season) to return the funds to your Roth account.

However—and this is a big however—if you’ve set aside more than $6,500 of emergency fund money inside the Roth (say, $11,000) and you withdraw all of those funds, you won’t be able to put all of them back. You can only deposit $6,500 a year, including your age 50+ catch-up contribution. Your Roth balance will be permanently lower by whatever amount you withdraw over $6,500. That sort of hit can play havoc with the Roth’s growth and return on investment.

In short, while you can use a Roth IRA as an emergency fund (in a serious crunch), you should never use emergency funds as a Roth IRA investment.

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