Retirees lack emergency savings to cover yearly unexpected expenses

As you gauge how much income you’ll need to pay for your living expenses in retirement, don’t forget to consider how you’ll cover unexpected costs.

More than 8 in 10 retiree households — 83% — will face unplanned outlays in any given year, according to new research from the Center for Retirement Research at Boston College. Among households that do experience unexpected expenses, the average annual amount spent across retirement is $6,000. Measured another way, the typical household will spend an amount equivalent to 10% of its yearly income.

Yet many households don’t have that available in emergency savings, according to the research. While roughly 58% have enough cash to cover unplanned costs for a single year, around 16% would have to tap their 401(k) or other retirement accounts and the rest — about 27% — would fall short even after using all their cash and retirement assets.

“About 40% of [retired] households do not have enough cash to cover even a single year [of unplanned expenses], let alone their whole retirement,” the research notes.

The research uses data from 3,427 retired households that have been part of the 2000-2020 Health and Retirement Study and the Consumption and Activities Mail Survey, both from the University of Michigan.

While experts generally recommend nonretirees have three to six months of living expenses set aside 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 across what may be a decades-long retirement.

As many retirees struggle to keep up with prices that continue to rise, considering unexpected expenses is an important part of evaluating retirement readiness.

“That helps you plan for liquidity versus your income needs,” said Anqi Chen, co-author of the report and associate director of savings and household finance at the Center for Retirement Research.

While some households may struggle to set aside money, “even small amounts of savings will help provide some sort of buffer for when these events occur,” Chen said.

Expenses are separated into three categories in the research:

• “Rainy day” expenses, such as car maintenance costing more than $500 or home maintenance of $1,000 or more.
• Family-related expenses, such as the death of a spouse or providing financial help to family.
• Health-care expenses above $500, such as dental expenses or prescription costs.

The Center for Retirement Research estimated that 60% of all retiree households will face a rainy day shock; 29% will have an unexpected family-related expense; and 58% will confront an unexpected health-care expense.

Higher-income retirees experience these unexpected expenses at a greater rate than those with lower incomes, according to the research. For example, about 45% of households with less than $50,000 in income face a rainy day or health-care shock in a given year, compared with 80% of those with $100,000 or more in income.

“This finding highlights the fact that households have some control over when and how much they spend,” the report notes.

So how much should you have set aside? Depending on a retiree’s individual situation, financial advisors may recommend anywhere from three or six months’ worth of expenses to a couple of years — or a variation of those parameters. Much of it will depend on your individual situation.

“What we usually tell clients is to think less in terms of months of expenses and more in terms of access to cash for surprises — health-care costs, home repairs or family needs,” said certified financial planner Joon Um, a tax advisor with Secure Tax & Accounting in Beverly Hills, California.

“For many retirees, that ends up being one year of core expenses, adjusted for guaranteed income like Social Security or pensions,” Um said.

The right amount depends on health, housing, income stability and how flexible other assets are, Um said.

“Retirees with steady income and liquid portfolios may need less cash, while those with higher medical risk or less flexibility need more,” Um said. “The goal isn’t to maximize cash. It’s to have enough on hand to avoid selling long-term investments at the wrong time.”

In other words, if you don’t have enough cash set aside, you could be put in a position of selling investments when the market is down.

However, having too much in cash comes with its own risks, said Peter Lazaroff, a chartered financial analyst and CFP, and the chief investment officer at Plancorp in St. Louis.

“Any time a retiree has more than two years of expenses in cash, it’s too much,” Lazaroff said. “From purely a mathematical standpoint, you’re giving up too much of a return.”

The biggest risk to your cash is inflation, he said. The latest reading of the consumer price index showed an annual inflation rate of 2.7% in December.

“Your cash just becomes less valuable every year,” he said. “You’re putting your purchasing power at risk.”

He recommends stashing your cash in a high-yield savings account — which right now generally earns more than 3% in interest, according to Bankrate — to help minimize the impact of inflation.