Retired people are advised to hold vastly more emergency cash than during their working years.
The typical rule of thumb for workers is to have cash on hand to cover three to six months of essential household bills.
But financial experts suggest retirees have a fund worth one to three years of their usual expenses after they start living on a fixed income and cannot replenish their savings so easily.
The exact size of ‘rainy day’ fund you should aim for varies depending on your circumstances, but you can get a good idea from typical spending patterns, according to Hargreaves Lansdown.
The firm recently released a study into average household expenditure at different ages, and how that can help determine what you need for emergencies.
People aged 60-plus have the lowest average essential costs at £1,392 a month, it calculated.
Savings fund: Keep a larger pot on hand if you are planning big-ticket purchases – many people book holidays or spend on cars on home renovations in early retirement
This is because they have often paid off their mortgage and no longer have work-related expenses such as commuting, says Sarah Coles, head of personal finance at Hargreaves.
But they are advised to put aside one to three years’ worth of this spending aside for unexpected bills – so £50,112 on average, if you are being cautious about your target.
The figures come from Hargreaves’ Saving and Resilience Barometer, which it compiles in partnership with forecasting firm Oxford Economics.
This is based on data from the Wealth and Asset survey by the Office for National Statistics – which draws its information from 10,000 households – plus other data from official sources.
Coles warns that when you stop working, usually at 60 and above, your emergency savings needs change.
‘When you’re on a lower fixed income, if you’re hit with costs out of the blue, you’ll need to dip into your savings, and it takes longer to rebuild them.
‘Having enough savings to cover a longer periods allows for more than one nasty surprise to hit before you’ve had time to recover.’
She points out many people have the opportunity to boost their savings significantly when they take a tax-free lump sum out of their pensions at retirement.
Pension experts: From left, Mike Ambery of Standard Life, Sarah Coles of Hargreaves Lansdown and Craig Rickman of Interactive Investor
Mike Ambery, retirement savings director at Standard Life, says: ‘An emergency fund remains just as important in retirement as it is during working life – perhaps even more so.
‘You don’t have the safety net of a salary to fall back on and may be relying on investments for income.’
He says in working life, an emergency fund is typically seen as a way to replace lost income if you lose your job, whereas in retirement it’s more about having funds available to deal with shocks without selling investments prematurely.
Craig Rickman, personal finance expert at Interactive Investor, says you should keep a larger fund on hand if you are planning big-ticket purchases in the near future.
Spending on things like new cars, holiday and home renovations are common in early retirement.
Other factors to consider are your attitude to risk and your life expectancy, he says.
Investing your pension: Hold more cash to avoid this nasty trap
There is an unpleasant trap – known in financial jargon as ‘pound cost ravaging’, or sometime sequencing risk – which can hit you hard if you invest your pension and markets suddenly collapse.
This can be especially damaging if it happens at the outset of retirement, but spending your cash fund instead of tapping investments at that point can save the situation.
Coles says for those using income drawdown to take an income from their pension, and emergency fund helps you get through difficult times in the stock market.
‘It means you can draw from your savings for a period instead, so you’re not eating into your pension and damaging its ability to recover when better times return to the markets.’
Rickman says: ‘If you continue to generate income from selling shares during a stock market slump, it may harm how long your pot lasts.
‘Essentially, if your investments have fallen in value, you’ll need to encash more shares to maintain the same level of income, shortening the lifespan of your savings.
‘A key thing to remember is that if you’ve depleted the cash pot, it’s important to top it back up to protect yourself from the next downturn, whenever it arrives,’ he adds.
Rickman says cautious investors may prefer an even larger cash holding than one to three years of expenses, but you need to be careful not to stash away too much.
‘Over longer periods cash savings tend to underperform other assets like shares and bonds, so a large allocation can drag on investment performance. And investment growth is crucial to give your retirement pot the best chance of lasting as long as you do.’
Ambery says one way to strengthen your safety net in retirement is by combining investments with guaranteed income.
He says the state pension – worth around £12,000 a year if you qualify for the full amount – will provide the bedrock, but you can also use some of your pension savings to buy a annuity that ensures essentials like food, utilities and council tax are always covered.
‘We’re also finding more retirees are choosing to annuitise in phases – securing guaranteed income at different points in retirement. This approach can offer some flexibility alongside the reassurance that basic costs will always be met.’
Tips on building an emergency fund for retirement
Sarah Coles of Hargreaves Lansdown offers the following suggestions.
1. Decide how many months’ worth of essentials you need to cover. Where you fall on the spectrum of one to three years will depend on your circumstances.
2. Think about personal factors when deciding how cautious you need to be:
– How many people rely on you financially
– Have you had health problems in the past
– Is your income secure or insecure (final salary pensions, annuities and state pensions are guaranteed for life, invested funds are more risky)
3. There’s a huge difference in what people consider essential.
Consider what is essential to you. Go through your spending and isolate the things you can’t live without, and what they cost. This will give you the monthly figure you should be aiming for.
4. If you don’t have enough set aside, you can set up a monthly direct debit into a savings account.
The best place for your emergency fund is an easy access savings account or cash Isa.
At the moment, you can get interest of up to 4.3 per cent on a cash Isa or 5 per cent on a savings account, so they are more than keeping pace with inflation. Check This is Money’s savings tables for up to date rates.
5. If you have built savings beyond what you genuinely need, you might want to consider using the excess to support other areas of your finances.
6. When you reach retirement and can draw 25 per cent tax-free cash from your pension, it’s an opportunity to bulk up your emergency savings substantially.
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