I Have A Pension: Do I Still Need An Emergency Fund?
For years, the standard financial advice has been simple: Keep three to six months of expenses in cash for emergencies.
That guidance makes sense for households that rely entirely on earned income. But for many military retirees with a pension and especially those with VA disability, this rule of thumb deserves a second look. When a significant portion or the entirety of your mandatory expenses is already covered by guaranteed income, your emergency fund doesn’t need to serve the same purpose it does for everyone else.
Why the Traditional Emergency Fund Exists
A traditional emergency fund is insurance; self-insurance to be exact. You are accepting the risk that in the short term, you can fund yourself against two main risks:
Loss of income
Unexpected large expenses
For someone whose paycheck could disappear overnight, cash reserves are critical. The standard advice is 3-6 months’ worth of mandatory living expenses saved into a highly liquid account such as a regular or high yield savings account. If you have stable pay, two incomes, and/or low expenses, you may feel comfortable with a leaner, 3-month fund. Alternatively, a 6-month fund might be more appropriate for those supporting a family on a single income or with unstable/uneven pay. Even with the occasional government shutdown, a 3-month fund is often appropriate for those in the military. When you decide your time in the military is over, you may consider an increase to a 6-month fund due to changing incomes and expenses. In either case, the emergency fund is there to become your income in case your normal income stops unexpectedly or is insufficient to handle large, one-time expenses.
But for retirees with reliable income streams, that first risk looks very different.
Guaranteed Income Changes the Emergency Fund Math
Military pensions and VA disability compensation have unique characteristics:
They are reliable and predictable
They are not tied to employment
They often adjust for inflation
They continue regardless of market conditions
So, what if those guaranteed income streams already cover your baseline needs such as a mortgage payment, utilities, food, and insurance premiums? How should you think about the amount you should keep for emergencies then?
From Income Protection to Event Protection: A Different Way to Size the Emergency Fund
Well first, perhaps take a moment to consider how exciting this is! Think about it:
Your guaranteed income covers your mandatory expenses.
Maybe I am naïve, but to me, this looks oddly like a definition of financial independence. Sure, you might not be able to accomplish all the goals you set out for your life, but at minimum, you have the income you need to keep a roof over your head, food on the table, and gas in the car. Any income beyond that is icing on the cake!
With that out of the way, now we can consider our emergency fund amount. Remember, there were two purposes to an emergency fund, and we’ve just eliminated one of them – income sourcing. The second, covering the costs of unexpected bills, remains. This is where the shift occurs. Instead of thinking about this in terms of 3-6 months income, now we can think about this in terms of what’s the worst thing that can happen that I don’t already have insurance for.
A quick trip to ChatGPT generates some of the most common large-ticket expenses to plan for:
Home repairs such as HVAC or roof replacement
An engine or transmission on your vehicle
Unplanned travel
Given these types of expenses, anywhere between $20,000 and $50,000 would almost, if not completely cover the cost.
The Trade-Off: Cash vs. Opportunity
As you consider how much to store away for those potential large expenses, keep in mind that too much cash in savings can be risky. Even highest of the high-yield savings accounts are generally only staying even with inflation. That means that if you have a lot of cash in a savings account, you may not be earning enough interest to keep up with the value of the dollar or worse, you may actually be losing value over time.
Peace of Mind Still Matters
There is a comfort factor to an emergency fund. If you decide that $10,000 would cover the worst thing that could happen to you, but you still can’t sleep at night because the account value is too low, consider the amount that would help you sleep at night. So your new number doesn’t become arbitrary, try to consider why your new number makes you comfortable. Quite often, we have a tendency to create the worst-case scenario to the 99th degree in our mind, when in reality, our worst case scenario may not even happen - ever. Try to find a balance between your worry, anxiety, and the reality that an event may actually happen. If you find yourself getting to a number beyond $50,000 or so, perhaps shifting risk to an insurance company might be a more appropriate solution. Before you head to the nearest insurance agent, perhaps use an outside party as a sounding board for your idea.
Setting Your New Number
The key to establishing your retirement emergency fund is that it is personalized to you. With guaranteed income that covers your mandatory expenses, your emergency fund shifts from income protection to event protection; an added source of comfort and confidence to your guaranteed income. You get to set the amount balanced between what could happen, what helps you sleep at night, and the risk of too much idle cash. When aligned, your emergency fund does exactly as it is designed; it offers the ability to respond with clarity and control when life inevitably throws a wrench in your plans.
Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Read the full disclosure.