Hello pension, bye-bye saving? Not so fast

By Walter Updegrave, senior editor


(Money Magazine) -- Question: I'm retired on a pension and will soon start receiving Social Security. So I'm wondering, once you're retired do you still need an emergency fund of three to six months' worth of living expenses as you did when you were working? --Jim, West Farmington, Ohio

Answer: Just because you're retired doesn't mean you still don't need an emergency fund. In fact, many retirees may actually want to keep more cash on hand than they did during their career.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

But let's begin by considering the case for maintaining at least a three to six months' reserve.

The argument you most often see for keeping an emergency cushion during your working years is that you may need some ready cash to tide you over in the event you lose your job. Given the millions of pink slips that have been handed out since the economy went into a tailspin in 2008, I don't think anyone would deny that's a good reason for keeping money on hand in secure and easy-to-access accounts like a savings account, money-market fund or short-term CD.

Of course, if you're retired and, as in your case, living on a pension and Social Security, you no longer have to worry about your income being interrupted by a job loss. Each month, you know you're going to get that Social Security payment and, assuming your former employer's pension plan remains solvent, your pension check as well. (If your company's plan runs into problems, the Pension Benefit Guaranty Corp. guarantees a basic level of benefits.)

But there other reasons besides replacing income that it makes sense to have extra cash set aside.

Unanticipated expenses. Cars break down and require major repairs or need to be replaced. And houses can provide a seemingly inexhaustible supply of big-ticket expenses what with roof leaks, periodic repainting or residing and other maintenance items.

Retirees may be especially vulnerable to unscheduled expenses. A few years ago when I interviewed Henry "Bud" Hebeler, a retired Boeing engineer who writes about retirement issues at Analyze Now!, he warned that retirement is full of financial "surprises," more of them bad than good. Specifically, he noted that costs that may have been covered by your company insurance during your career -- dental work, vision care, other medical tests -- typically aren't by Medicare and pointed out that he spent $6,000 alone on hearing aids.

Inflation. Most corporate pension payments aren't adjusted for inflation. So to the extent prices rise, the purchasing power of your company pension may very well decline from year to year. Social Security does provide for inflation increases, although because of the way Social Security's cost-of-living adjustment is calculated, recipients received no COLA in 2010 and may not get one until 2013.

Even when inflation increases do come through, that doesn't necessarily mean that the value of your Social Security check will rise as fast your actual expenses. Having some extra cash on hand can help you bridge any gap, at least for the short term.

Market fluctuations. Now let's turn to why you may want to have even more than three to six months' worth of cash as a reserve.

You didn't mention having resources beyond a company pension and Social Security. But most retirees will also be looking to generate income from the money they've accumulated in 401(k)s, IRAs and other retirement accounts. Some may do that by simply withdrawing cash as they need it, others may set up some sort of systematic withdrawal system and still others may rely on a combination of withdrawals and regular payments from an income annuity.

The more you'll be depending on income from retirement savings to fund your post-career lifestyle, the more important it is to have an adequate stockpile of cash.

Why? Well, assuming that a good portion of your retirement savings will be invested in stock and bond mutual funds or similar investments, the value of those assets will go down during market setbacks. If you're withdrawing money from your portfolio at the same time that its market value is taking a hit, the double-whammy of withdrawals plus investment losses could so deplete the value of your account that it will have trouble recouping lost ground even when the market rebounds.

To the extent you're able to postpone or at least pare withdrawals from your portfolio during downturns by drawing cash from a reserve account, you can give your portfolio some breathing room and increase its chances of recovering enough to support you throughout retirement.

Reasonable people can disagree about how large a cash cushion is necessary for a buffer from market disruptions. Clearly, the more you devote to cash, the less you'll have available for the long-term growth you'll need to maintain your living standard in the face of inflation. But if you're relying on your retirement investment portfolio to meet a meaningful portion of your living expenses, I'd say you want to consider keeping 18 to 24 months' worth of withdrawals in cash or cash equivalent assets. In short, roughly enough to get you through most market downturns.

Bottom line: the ultimate purpose of a cash reserve is to give you flexibility to deal with unforeseen events. And since you probably have less wiggle room to deal with uncertainty in retirement than during your career, all the more reason to maintain an emergency fund that can serve as a buffer against unanticipated expenses and financial setbacks. To top of page

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