From restricting our liberty to changing work patterns, the Covid-19 pandemic changed our lives in many ways. As a result of closed shops, restaurants and borders, many people report that they have saved money over the last couple of years.
While it isn’t the case for everyone, MoneyAge claim that nearly half of Brits now have enough in savings to support them for six months if they lost their income.
Having an emergency fund like this to support you in such circumstances is crucial throughout all stages of life, but it could be even more important if you’re in or approaching retirement.
So, what exactly is an emergency fund, and why is it so important? Read on to find out.
An emergency fund will save you from the unexpected
An emergency fund is a store of cash that you put aside for unplanned expenditure, such as an unexpected bill or a short period of unemployment.
It is typically kept separate from the rest of your money, and you won’t generally include it when you’re looking at your other short- and medium-term savings goals.
Financial experts generally recommend that your emergency fund consists of three to six months’ worth of essential expenditure.
If you are approaching or in retirement, many financial planners will recommend that your emergency fund is larger. This is both to cover more expensive potential costs, and because you are in a more vulnerable financial position since you rely on your pension rather than income from employment.
An emergency fund helps you stay prepared in the event of financial trouble
The potential risks to your income have been emphasised by the pandemic. Whether it’s through job loss, sickness, or lockdowns preventing you from working, the possibility that you could lose your income is ever-present.
Having plenty of savings in a rainy day fund means that you have money to rely on in the event of a sudden loss of income, or if you’re faced with an unexpected expense.
Surprise payments such as fixing a broken boiler or damaged roof can happen at any time and can leave a sizeable dent in your savings.
Lastly, an emergency fund can simply bring you peace of mind. Having a store of money ready for the worst can give you a greater sense of confidence in your finances in day-to-day life and help reduce your stress levels when something does go wrong.
The value of your pension relies on the performance of the stock market
Once you leave the office for the final time and live your life without the stress of work, you also leave your monthly pay cheque behind. Instead, you are likely to mostly rely on the savings you have built up during your working life to sustain your lifestyle.
If you have a defined benefit (or “final salary”) pension, your income will be determined by factors such as your salary when you retire and the number of years you worked for your employer.
If you have a defined contribution pension, the value will generally be determined by the performance of the underlying investments.
If, when you come to retire, the value of these investments has recently fallen, you may have to encash more “units” of your pension to generate the income you need. It could mean that, when markets recover, you have fewer units to benefit from this subsequent growth.
Significant market losses in the early years of your retirement can increase the risk that you deplete your fund, even if you benefit from strong returns in later years.
For this reason, many experts encourage people at or in retirement to keep a larger “emergency fund”. Holding one to three years’ worth of income in cash means you could use this money as income in the event of a market fall, meaning you don’t need to encash your pension.
There are a few things to consider when you retire
Another reason to consider holding a larger emergency fund in your retirement is because it can be harder to generate additional income to top up your fund.
While employed, you might have been able to build up your emergency fund by working overtime or doing additional freelance work on the side. In retirement, it can be harder to do this.
This means that, if you encounter a surprise payment without an emergency fund, you may have to draw more of your pension to cover it. This could affect your standard of living.
Finally, you may have to cover the costs of later-life care should you or your partner need it. Care costs can be remarkably expensive, with The Conversation reporting that one in seven older people could incur care costs of more than £100,000.
Having an emergency fund large enough to cover some of these costs could save you from dipping into your legacy or, worse, running out of funds entirely down the line.
Get in touch
If you want to discuss how to make an emergency fund, or how to plan effectively to ensure you can deal with unexpected events, please email info@investmentsense.co.uk or call 0115 933 8433.
Please note
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
