How Much Cash Should You Keep in Retirement?

Transcript

How much cash should you keep in retirement? A lot of people get close to retirement and realize they've spent years focused on working, saving, investing, and living life, but maybe not as much time thinking about how that money is actually going to be used. That's usually where cash starts getting a lot more attention. How much should be sitting there? What is it there for? And how do you know if it's too much or too little?

It depends on the plan, of course, and there's no universal number that fits everybody. So let me show you the framework I like to use. Picture someone heading into retirement with a solid portfolio, decent savings, and maybe Social Security coming in, maybe later. On paper they're fine, but they haven't really separated the money they may need soon from the money that's meant to stay invested throughout retirement, which could be another 30-year window. There's a good balance between what to keep invested for growth and what to hold in a more stabilized bucket. Because if every dollar of spending feels tied to the portfolio, then every rough market starts to feel a little personal, and heavier than it needs to.

That's where an income reserve, or cash reserve, comes in. When you're working, income is pretty easy to understand. You do a job, you get paid, you pay the bills, life moves along. In retirement, that paycheck goes away, so the question becomes, where is the income coming from now? Maybe part of it is Social Security. Maybe part is portfolio withdrawals. Maybe there's a pension in the mix, maybe not. But one way or another, the money has to come from somewhere. Using this income reserve intentionally can be a big help, mentally and for the plan itself. It's really just money set aside to help cover planned withdrawals once work income is gone.

If you want a simple way to picture it, think of it as giving near-term spending its own lane, its own bucket, even its own account, which is what we'll call the income reserve. You're not trying to solve everything with cash. You're just making sure the next chunk of spending has been thought through and protected.

So how much cash should you keep in retirement? Normally, it's best to hold one to two years, depending on your situation, of planned portfolio withdrawals in cash. This is separate from the emergency fund, because these are expected withdrawals. The emergency fund is for the unexpected ones.

Let's use a simple example. Say someone expects to spend about $90,000 a year in retirement to pay the bills, live life, and run the show. And say Social Security covers about $40,000 of that. Now we know about $50,000 needs to come from the portfolio to cover the gap, and that $50,000 is the number I'd focus on. So how much should we keep in cash? In this example, we'll use a two-year cash reserve, so $100,000. I think that's a much better way to approach it than pulling a number out of the air and saying, I don't know, that feels about right, which is how a lot of people end up doing it. That's the shift I want people to make. Instead of asking how much cash should I have, ask how much am I likely going to need from the portfolio over the next year or two? That gives the number some structure.

To make it feel more real, here's how it can show up inside an actual plan or balance sheet. These aren't real people, they're our friends Mark and Sarah Demo, but you can see we even label this bucket under their jointly held accounts on the balance sheet. I like doing that because it keeps the purpose clear. It's not just some random cash sitting there, and we don't bundle it all together. This is money with a job, money with a purpose. As the bucket goes down, as withdrawals are taken for spending in retirement, we can replenish it using multiple accounts, a few accounts, or one account, depending on the situation and what markets are doing. So it's there to support near-term withdrawals while the rest of the portfolio keeps doing what it's supposed to do over time. That alone can make the plan feel a lot more grounded. It can also give you more flexibility and control around where withdrawals come from, and that can be a big deal for taxes and not tipping Uncle Sam in retirement. I don't mean that in a magic-solution kind of way, more in a practical sense. We can replenish the income reserve from different accounts depending on your tax situation that year, while also alleviating the risk of sequence of returns, or taking money out in a down market from the portfolio.

What does that $100,000 actually do? First, it covers the next stretch of planned withdrawals, so we have a good runway, and that matters because spending doesn't stop just because markets are having a rough year. Second, the portfolio doesn't need to be interrupted every time cash is needed. In a position of strength, we can replenish from multiple sources, but we don't have to when markets are down. And lastly, maybe most important of all, it can make retirement feel steadier. You might feel more comfortable mentally, less scrambling, less staring at the market or getting that anxious feeling when it isn't doing well. If you're going to be retired for 20 or 30 years, you're going to go through downturns. The market isn't going up and to the right the entire time. All this means is it'll be a lot less "this is uncomfortable."

So when I think about cash in retirement, it goes back to that simple question. How much do we expect to need from the portfolio in the next year or two? That's a better starting point. Not necessarily the be-all end-all, but a good starting point. From there, you can decide what amount makes sense in the context of the rest of the plan, the other income sources, the account mix, and most importantly, the person sitting across the table, because this really does depend. Some people want a little more set aside. Some need or want less, because they have more income sources doing more of the work. Give near-term withdrawals more structure, so the rest of the plan has room to breathe.

And to say it clearly, this isn't a recommendation for everybody watching. If you're making real retirement decisions, you want to look at your own numbers, your own tax picture, your income sources, and how the full plan is set up before making changes. If this was helpful, I can do more on retirement income, withdrawal strategies, and how I think about the portfolio once work income goes away.

Hosted byNick GeorgeCFP®, ChFC®, CLU®, IWA™FounderView bio →

Back to Clarity Corner