23 Jun How much cash should I set aside before I retire?

Q. I’m working on our retirement plan and I often hear the recommendation about having one to two years of living expenses in stable accounts. While I do agree, what would be the most efficient means to build this cash or a more liquid reserve position? Should I be selling mutual funds and stocks or start putting new cash away? I’d hate to negatively impact our tax bracket.
— Getting closer

A. Having sufficient cash reserves to cover expenses and potential emergencies is an important factor to consider when planning for retirement.

The amount of reserves to set aside depends on several factors, such as expected income in retirement from Social Security and/or a pension, investments, the level of risk in the investment portfolio and more, said Deva Panambur, a fee-only planner with Sarsi, LLC in West New York and an adjunct professor of personal finance at Montclair State University.

“Generally, any expenses in retirement that you are not able to cover using your expected income plus a buffer for potential emergencies should be held in highly liquid, stable investments such as bank accounts and money market funds,” Panambur said. “The rest of your liquid assets can be invested in stocks, bonds and other investments that tend to do well over the long term but can be relatively volatile in the short term.”

He said if your investment portfolio has relatively higher risk, such as in portfolios with a higher percentage in stocks, then you would want to maintain a higher amount of cash reserves in stable accounts.

As with everything in financial planning, these decisions should be taken in a holistic manner within your comfort level and stated objectives. The planning could turn out to be complex and complicated, he said.

Panambur said it’s important to plan for retirement well in advance, years before the actual date of retirement, so that you will not have to make sub-optimal decisions such as selling your investments to build cash reserves.

Ideally, he said, you should build up the cash reserves using your cash flow surplus over a few years before retirement and allow your investments to compound.

“Selling appreciated assets in your taxable account or withdrawing a large amount from your retirement accounts will result in avoidable taxes and in the case of the latter, depending on your age, you may have to pay a penalty as well,” he said.

If you have unrealized losses in a taxable account, you could sell the investments to offset gains elsewhere or get a $3,000 per year deduction against your regular income, he said, noting that wash sale rules require you to find an investment that is not substantially similar.

“However, using the proceeds from the sale of depreciated assets to build cash reserves, would preclude you from participating in the appreciation when the investment recovers,”Panambur said. “On the other hand, you could use the income from your investments, such as dividends and interest, to build your reserves.”

Generally, he said, you should delay withdrawing from retirement accounts such as tax deferred accounts and tax-exempt accounts.

“However, In the early years of retirement there could be a potential for tax strategies such as Roth conversions,” he said. “These strategies will impact your cash flows and cash levels and should be evaluated in a comprehensive manner considering all the moving parts in your situation.”

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This story was originally published on June 23, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.