Retirement: Managing unexpected expenses, an emergency fund
You might expect plenty of things in retirement – spending time with family and friends, traveling, focusing on your health wellness.
But you're also living in fear of unexpected expenses. In fact, roughly half of near-retirees and retirees say that’s the biggest fear they have/had about retirement, according to a recent survey published by Empower.
"Retirement is effectively a great unknown," says David Blanchett, head of retirement research for Morningstar Investment Management. "The actual date of retirement is unknown for most, when retirement is going to end, i.e., death, is unknown, and we do - and spend – in retirement is unknown, especially before it begins."
Two questions: Will you face unexpected expenses in retirement and, if so, how best to plan for those expenses?
Expect a spending surge. Research by J.P. Morgan Asset Management shows that household expenses, in general, tend to decline after age 45. But there is a spending surge around just before and after retirement, usually the result of increased travel, housing-related changes – such as relocation or renovation – and other types of lifestyle changes.
Expect spending shocks. Research also shows a high degree of "spending volatility" during retirement. According to the JPMorgan Chase Institute, older families show more stable income, which is expected given more stable income streams – like Social Security income and annuities – but spending volatility is high and "may result from a higher probability of unexpected medical expenditures during older age."
And according the Society of Actuaries shows the most common financial shocks during retirement being home repairs and upgrades and major dental expenses.
"Unexpected expenses are inevitable in life, and in retirement," says Dana Anspach, CEO of Sensible Money. "Sometimes it happens because you forgot about future big-ticket items, like auto purchases or major home repairs ... But more often than not, it comes from a family emergency, perhaps an adult child that needs your financial assistance."
Getting ahead of unexpected expenses
Evaluate and risk manage. Step one, says Keith Whitcomb, director of analytics at Perspective Partners, is getting an understanding of where those unexpected expenses could pop up. First ask: What are your big-ticket budget items that are subject to volatility? And two, determine if it’s an insurable exposure? "Try to eliminate catastrophic outcomes where possible by getting coverage," he says. "While this will increase your expenses, if it allows you to sleep at night, it may well be worth the cost."
Put a plan in place. Whitcomb also recommends having a financial action plan in place in the event of an emergency. "The plan should be codified so that all in your family know what to do financially in the event they need to act," he says. "The plan will detail your insurance coverage and an order of funding alternatives.”
Have an emergency fund. Typically, the first line of defense, says Whitcomb, is your emergency fund. How much should you have in that account? According to JPMorgan Chase, families ages 65-plus with income less than $29,000 need a little bit more than $2,300 set aside while those with income greater than $95,000 need a little bit more than $13,000. A middle-income family meanwhile would need about $5,000 to cover "concurrent adverse income and spending shocks."
For her part, Sharon Carson, a retirement strategist with J.P. Morgan Asset Management, says having a cash buffer for out-of-pocket heath care expenses and long-term care expenses is also necessary. For instance, expected health care costs are projected to rise from $5,300 for a 65-year Medicare beneficiary in 2020 to $16,810 for a 95-year-old beneficiary.
Managing your emergency fund
Once you have an emergency fund in place, evaluate all your other options. What might those options be?
HELOCs and HECMs. If you own a home consider a home equity line of credit, or HELOC, says Anspach. "They are typically easy to set up and interest rates are low," she says. "Then you can be strategic about how to withdraw funds from other places in a tax-efficient way to pay it off."
You may also be able to draw on the equity in your home through a reverse mortgage – a home equity conversion mortgage, or HECM, says Whitcomb. "Having the HECM as a source of backup funding may be a good 'insurance policy' to have available for just this sort of event," he says.
Borrow cash value. If you have a life insurance policy with cash value, you may be able to use that, says Anspach. "The insurance company can tell you how much you can withdraw or borrow from the policy without putting the policy at risk of lapsing later in life."
Tap your health savings account? Consider tapping your health savings account or HSA – if you have one. "If you paid for medical expenses out of pocket during prior years where you had your HSA, as long as you have records, you can make a tax-free withdrawal from your HSA up to the amount of documented qualified medical expenses," says Anspach. These withdrawals will be tax-free.
Tap your Roth IRA. Withdrawals from Roth accounts are not included in many of the complex tax formulas that apply to retirees, such as your eligibility for the health care tax credit, or the formulas that determine how much of our Social Security income is taxable or what your Medicare Part B premiums will be, says Anspach.
Explore long-term options. In the case of medical expenses, Whitcomb says there may be longer term financing arrangements available through the provider. "You also may be able to negotiate a reduction in your bill ... As a result, you could effectively reduce the debt and lengthen out the payments to better fit your retirement budget."
Borrow against your stock portfolio. Don't sell investments during a market downturn to pay for unexpected expected expenses. Borrow against them instead. "Most brokerage firms offer some type of pledged asset line of credit where your investments serve as collateral for a low-interest rate loan with flexible payment options," Anspach says. "This works great for temporary financing needs, such as the need to put a down payment on a new home before your existing home has sold."
If markets are favorable, however, you may want to liquidate specific investments in your portfolio, says Whitcomb.
Other options. You could also draw on other forms of financing like a credit card. "While it will likely be expensive, for a short-term emergency, it may work," Whitcomb added.
Robert Powell is the editor of TheStreet’s Retirement Daily www.retirement.thestreet.com and contributes regularly to USA TODAY. Got questions about money? Email Bob at email@example.com.