What Size Cushion?

DO YOU REALLY NEED an emergency fund equal to six months’ living expenses? Partly, that’s a matter of personal preference and hence how much you need to set aside to feel financially secure. But you should also give some thought to your job situation.

While you might tap your emergency fund to pay for a major car or home repair, the No. 1 reason to have an emergency fund is to cover a prolonged period of unemployment. Indeed, if you’re retired and don’t rely on a regular paycheck, you arguably don’t need a separate emergency reserve.

Still in the workforce? If your job is tenuous or you’re self-employed, you may need the full six months of emergency money and perhaps more. But if your job is reasonably secure, you might keep just three months’ living expenses in a savings account. Similarly, you might opt for a smaller emergency fund if your spouse also works, unless there’s a risk you could both lose your jobs at the same time because you work for the same company or in the same industry.

Our Humble Opinion: As you save for retirement and other goals, you may find yourself socking away money not just in 401(k) plans and individual retirement accounts, but also in a regular taxable account. You can tap that taxable account at any time without worrying about the 10% tax penalty that’s typically levied on retirement account withdrawals before age 59½. As your taxable account grows, keeping a separate emergency fund may seem unnecessary. After all, if you lost your job, you could always dip into some of the retirement money you have in your regular taxable account.

What if you find yourself out of work and you have little or no money in your taxable account? You might be compelled to dip into your retirement accounts. There will be no taxes owed if you’re withdrawing your regular annual Roth contributions—a point we made in the previous section. But what about other retirement accounts? As the tax chapter explains, the consequences may not be as dire as you feared.

Next: Step 2: Insurance

Previous: Step 1: Emergencies

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