How Much Cash Should I Have in Retirement?

How Much Cash Should I Have in Retirement
Elliott Appel, CFP®, CLU®, RLP®

Elliott Appel, CFP®, CLU®, RLP®

Welcome! I'm the founder of Kindness Financial Planning, LLC, a fee-only, fiduciary advisor located in Madison, WI working virtually with widows, caregivers, and people affected by major health events across the United States. When I'm not helping people live their ideal life, I'm often cooking for my wife, playing tennis, or hiking.

Last Updated on October 25, 2022


One of the common questions I receive from people approaching retirement or people in retirement is, “How much cash should I have in retirement?” 

After many decades of saving and investing, it can be a strange experience going the other way. You’ve been taught to save and save, and now you have to start spending from the pool of assets you’ve spent a lifetime building. 

Many are unsure how much cash is appropriate. 

Let’s answer the question of how much cash you should have on hand in retirement. 

What is Cash? 

First, let’s define what “cash” means. I’ve seen articles make cases for cash substitutes that are not cash substitutes. 

Cash is cash, which I know is strange to say, but given what is on the internet, it’s necessary. It’s cash in an FDIC-insured bank account. 

It’s easily accessible. You can go to the bank and withdraw it the same day. It’s cash you can move to another account electronically without any delays. You can wire it to another account the same day. 

It’s not certificate of deposits (CDs). It’s not dividend-paying stocks. It’s not cash in an insurance policy. 

Cash is easily accessible without penalties or taxes. 

Why Cash is Important in Retirement

Cash is important to retirees because it helps support spending, emergency expenses, and can provide peace of mind, particularly when first transitioning to retirement. 

Support Spending and Emergency Expenses

If you are in retirement and have a portfolio of stocks and bonds, cash helps provide flexibility with how you manage that portfolio. 

Instead of needing to sell stocks or bonds each month, cash can support your everyday living expenses, such as a mortgage, food, travel, etc. It can also support emergency expenses, such as a new roof, car repair, or traveling to see a sick relative. 

Without needing to do anything, cash is available in your bank account to support spending. 

Helpful with Transition to Retirement

Cash is also extremely helpful in the transition to retirement. Many people are unsure how the transition to retirement will go and how they will take withdrawals from their accounts. 

I’ve found that people who have extra cash on hand, potentially more than they are normally used to, find the transition easier. If you can see exactly where your spending is going to come from the first year or even two of retirement, you may be less worried about the stock or bond market ups and downs. 

When you are earning an income, it’s easy to see where money is going to come from for living expenses, but relying on a portfolio can feel uncomfortable at first. Having cash on hand may ease the transition as you become more comfortable with taking portfolio withdrawals. 

Comfort and Peace of Mind

Cash can often bring comfort and peace of mind. It doesn’t fluctuate like stocks or bonds. 

You won’t wake up a year from now and see your cash down 10% or 20% like you could with a balanced investment portfolio.

People like knowing they can login and see exactly how much they have and that it won’t fluctuate. 

The downside to this is that inflation eats away at cash. Inflation is known as the silent killer because it slowly (or rapidly if inflation is high) eats away at your purchasing power. If you have $50,000 in cash and inflation was 5% over the past year, your $50,000 can now only buy about $47,500 worth of stuff. 

Despite inflation hurting cash, cash is important because it can provide peace of mind needed to stick with an investment strategy. 

How Much Cash Should I Have in Retirement?

First, let me let you in on a little secret. There is no “right” answer. Like most personal finance, the answer is personal. 

There is a range of cash levels that may make sense for you. 

If you’ve read other articles, you’ve likely encountered the following rules of thumb:

  • 3-6 months’ worth of living expenses
  • 12 months’ worth of living expenses
  • 2 years’ worth of living expenses 

I’ve personally met people who had a successful retirement with these different levels of cash. 

Let’s explore the reasoning and pros and cons of each level of cash in retirement. 

3-6 Months’ Worth of Living Expenses

Having 3-6 months’ worth of living expenses is a common rule of thumb and one I like for many retirees. 

Pros

The pros of having 3-6 months’ worth of living expenses is that you have enough to cover living expenses for a fourth or half a year, which means you don’t need to replenish your cash often.

If you are managing a portfolio, that means you need to raise cash 2 to 4 times a year, which shouldn’t take too much time. 

Also, since most of your money is invested and not sitting in cash, you have less of a drag on investment returns. Cash normally has a low yield compared to other investments, which means if you hold more of it, you normally lower the overall return you might earn. 

Cons

The cons of having 3-6 months’ worth of living expenses is that it can be uncomfortable for some people. If you are going through a stock market decline like 2008 and 2009 and see stocks down 50%+, you may be more tempted to sell a portion of your portfolio or all of it to go to cash at one of the worst times possible. 

Having too little cash and abandoning your investment policy statement may lower your long-term returns more than if you had just held an extra 6-12 months’ worth of cash. 

Another con is you may need to trade the portfolio more, which requires extra time you may want to spend with family or enjoying hobbies. 

12 Months’ Worth of Living Expenses

Christine Benz, Director of Personal Finance for Morningstar, says she likes 1 to 2 years of expenses in cash. I’m a big fan of Christine’s work and find one year is a sweet spot for many people, but like she says, you can adjust the amount based on your risk preferences.  

Pros

If you aim to hold about 12 months’ worth of living expenses in cash, you may only need to replenish your cash bucket one or two times a year. 

Another benefit is that when the stock or bond market drops, you don’t have to worry about how your living expenses will be met. You already have a year worth of cash to support regular spending needs and emergencies. 

Lastly, if you have a year worth of cash, you may be more willing to invest more aggressively, which may earn a higher rate of return over time. Some people are willing to accept more risk in their portfolio if they feel comfortable knowing they have cash available for a year. 

Cons

One con of having a year worth of living expenses is that it may be a drag on your returns. Cash often earns a lower rate of return than a balanced stock and bond portfolio, which means if you have cash that could be invested earning a higher rate, you may be missing out on those returns. 

Similar to the drag on returns, inflation also has the opportunity to eat away at the purchasing power. If inflation is 8% over the year, your purchasing power went down 8%. You can only buy about 92% of what you could have the year before. 

Lastly, if your cash is earning interest, that may be taxable as ordinary income instead of capital gains in a brokerage account. If the money is invested in investments that have capital gains treatment, your long-term capital gains rate is likely lower than your ordinary income rate. 

2 Years’ Worth of Living Expenses

Some people recommend 2 years worth of living expenses. This may be too much for many people, but for people with a conservative risk tolerance, two years may be the appropriate amount to help them sleep at night. 

Pros

A pro of having two years’ worth of living expenses in cash is that when the stock and bond market goes through volatile times, you may worry less because you know how you will support your spending for the next two years. 

Another pro is that you don’t need to think about replenishing your cash bucket very often. Depending on how much you are willing to allow your cash bucket to drop, you may only need to create cash from your portfolio once every year or two. 

Cons

A con of having two years’ worth of living expenses in cash is that it may be a drag on investment returns. For example, if you had $120,000 in cash to support spending and your portfolio earned 6%, you may have missed out on $7,200 in growth. Over a year that may not be much, but if you compound that over 20 years along with the additional missed returns, that can add up to a sizeable sum that could have been used to increase your spending, reduce the risk you need to take in the portfolio, or pass on to an heir as a legacy asset. 

Similar to holding one years’ worth of cash, inflation may eat away at your purchasing power over time. You may not feel the effects of inflation over a year or two, but if you compound that over 20 years, inflation may reduce the amount your cash can buy. 

Also similar to holding one years’ worth of cash, the tax consequences of interest is usually less favorable than long-term capital gains from a brokerage account. 

Summary

There is no perfect amount of cash. For many people, a range of cash may be appropriate, and it may change over time.

You may feel like you need more at the start of retirement, but as you get comfortable with taking portfolio withdrawals, you may be okay holding less cash. 

While cash may be a drag on investment returns and inflation can hurt its purchasing power, cash allows many people to sleep better at night. Finding an appropriate allocation to cash that allows you to stick with your investment strategy is the key. 

Where I Don’t Like Holding Cash

I see nonsense on the internet about people who have come up with creative ways to hold their cash or see other investments as cash substitutes. Let’s go through some of those ideas, and why I don’t like them. 

Home Equity Line of Credit (HELOC)

Some people view their home equity line of credit as cash. It’s not. 

If you don’t have it open, you may not be able to open it when you need it most. Many large banks stopped offering HELOCs during the COVID pandemic because of the uncertainty and risk.

If you already have a HELOC open, read the fine print. If you have a zero balance because you planned on using it in an emergency, the bank may be able to close your HELOC. You may also have your line frozen or reduced. 

Cash is helpful because it’s liquid and accessible any time. A HELOC is not accessible any time, and the terms may change. 

Certificate of Deposits (CDs)

CDs also are not cash. CDs normally can’t be accessed within a certain period of time. For example, if you buy a two year CD, you may not be able to access the money for two years. If it can be accessed, there may be a penalty for accessing it. 

Money Market Accounts

Plenty of people are going to disagree with me on this one, but I don’t see money market accounts as an appropriate place for most cash, particularly cash in emergencies or if this is the only source of your cash. 

The reason I don’t like holding cash in money market accounts is that some money market accounts can impose liquidity fees or gates. If you are in a money market account that can impose liquidity fees or gate access to it, you may not be able to get to your money or, if you do, only get to less of it at a time when you need it most. 

Plus, I’ve found the yield on some FDIC-insured bank accounts are around the same yield as money market funds. 

Insurance Policies

If your insurance policy has a cash value component, I still don’t like seeing this as cash because it’s usually not easily accessible, such as the next day. There is usually paperwork or other steps you need to follow to take money out.

Plus, if you take money out, you may need to watch the policy more closely to make sure there is enough cash value to support the insurance policy charges to reduce the likelihood your policy lapses from an insufficient cash value. 

IRAs or 401(k)s

Although you can have cash in IRAs or 401(k)s, withdrawals are normally taxable as ordinary income. If you need to withdraw money, you may owe ordinary income taxes. 

If you need to take a large withdrawal, that may be fully taxable to you. I’ve seen situations where people needed to make a large withdrawal, which required them to take even more money to pay the taxes on the withdrawal. 

Cash should be easily accessible without tax consequences. 

Where to Consider Keeping Cash

Now that you know where I wouldn’t keep cash, here are a few options of where I would keep cash. 

Bank Account

It probably comes as no surprise that I say to consider keeping cash in your bank account. 

Bank accounts that are FDIC insured cover up to $250,000 per depositor, per insured bank, for each account ownership category

You normally can access your money within a day or two without needing to go through many steps. 

Brokerage Account

Although I don’t normally like using money market funds for holding cash, a brokerage account can be a useful place to hold cash. Some brokerage companies sweep your funds to an FDIC-insured bank account while others leave it in cash or invest it into a money market fund. 

Like a bank account, brokerage accounts are usually easily accessible if you need cash for spending or an emergency. 

Roth IRA

A Roth IRA can be a reasonable place to have cash if you have less after-tax funds. 

Roth IRA contributions can be withdrawn any time without penalty. Although I wouldn’t make a habit of storing your cash in your Roth IRA for emergencies, it is an option. 

Home

A common question I receive is, “How much cash should I store at home?”

Personally, I don’t keep more than a few hundred dollars at any time. When you store cash at home, you run the risk of losing it or having it stolen, even if it’s in a safe. There are plenty of stories about thieves taking a safe out of the ground and leaving with it. 

I like the idea of having enough in cash at home to cover emergency supplies, lodging, or other unforeseen events if I can’t pay with a credit card. 

Similar to how much cash is appropriate in general, some people may feel more comfortable holding a higher amount at home. 

Final Thoughts – My Question for You

Deciding how much cash to have in retirement, particularly in the transition to retirement, can be challenging. 

There are many different rules of thumb and general advice online.

You should think carefully about a comfortable level for you, weigh the pros and cons, and see how it feels. From there, you can adjust. 

As you think about where to keep the cash, think about the ease of accessibility, liquidity, and taxes of where you keep cash. Can you easily access the cash in emergencies? Is there a chance you can’t access it? How will the taxes affect your tax return? 

I’ll leave you with one question to act on. 

How much cash do you currently have available? 

Disclaimer: This article is for general information and educational purposes only and should not be considered investment, financial, legal, or tax advice. It is not a recommendation for purchase or sale of any security or investment advisory services. Please consult your own legal, financial, and other professionals to determine what may be appropriate for you. Opinions expressed are as of the date of publication, and such opinions are subject to change. Click for full disclaimer.

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