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Your Emergency Fund: What Qualifies as an Emergency?

This article was written by in Saving. 12 comments.


Having an emergency fund, money set in an easily accessible location like a savings account earmarked for certain situations, is one of the first steps to being financially secure. This is common advice, particularly among financial advisers. Ideally, one wouldn’t tap the emergency fund at all. That sacrifices some earning power because even high-yield savings accounts lose ground to inflation. In return for that sacrifice comes some stability. With an emergency fund in savings rather than the stock market, you don’t have to worry about a potential loss if you need the money in a down market.

If you can plan in advance and protect yourself, you can help reduce the sting of an emergency.

There is, however, a difference in opinion about which circumstances qualify as emergencies. The biggest emergencies would arise with any event that eliminates an income source for an extended period of time.

Legitimate emergencies

Sudden job loss. For many people, the primary source of income, and thus the ability to pay for expenses, is a job. Most people in the United States trade their time and effort for a paycheck, relying on a company, small or large, to accept that time and effort and provide remuneration. When job loss is sudden, the primary source of income could disappear just as quickly. Very few of us are “entitled” to a severance bonus, providing a cushion to ease the fall for a period of time, so we must plan accordingly.

It’s dangerous to place your ability to earn income in a sole decision maker focused on a company’s bottom line. As an individual, we each must take our income into our own hands as much as possible, and that includes always being prepared for job loss. Part of that preparation involves having an emergency fund available, keeping a current resume, networking with colleagues, seeking recommendations, and studying the industry.

Even with preparation, the loss of a job can be damaging to your finances, and the effect can last long after you find your next job.

Death or medical emergency of a family member. While life insurance can help deal financially with death, it doesn’t cover everything. There is an entire industry designed around planning for death, but an emergency fund will always be necessary. As relatives age or gradually experience a decline in health, you have time to develop expectations and prepare financially, but unfortunately, death is not always this graceful. Emergency funds can be used to help pay for these hopefully infrequent events, from flights to visit distant family members to final arrangements.

Hurricane KatrinaActs of nature. In New Orleans prior to Hurricane Katrina, residents wary about hurricane damage to their homes were encouraged to buy insurance policies covering wind and rain damage. Many insurance policies provided no relief following Katrina because the damage done to homes was determined to be due to flooding. According to USA Today, only one-third of homes carried federal insurance which included protection from flood damage. Many residence thought they were covered in the event of a hurricane, but the insurance companies disagreed.

A typical emergency fund with three to six months’ worth of expenses may not have solved all problems in this situation, but it could have helped. Natural disasters are not always as damaging as Hurricane Katrina, and planning for total destruction will in most cases be excessive, but when designing an emergency fund, it’s helpful to factor in what is likely for your location.

car accidentCar accidents. Auto insurance is generally helpful when it comes to covering for damage due to car accidents, whether caused by you or another party. Often, insurance won’t cover everything you need. Your emergency fund may need to at least cover your deductibles, but also fill in any gaps left after payments arrive. The fund can help pay for a new car if needed.

Surprise tax bills. While review and planning should prevent this occurring, occasionally the IRS finds something overlooked. It happens to even the most diligent. The IRS will usually allow a payment plan to extend repayments over time for an additional fee, but an emergency fund can help cover the liability.

Delay in income. I used to work for a non-profit which, before I had started working there, had a nasty reputation of not keeping enough funds in their payroll account to cover the paychecks for the ten or so on staff. I’ve had friends working for start-up internet-based companies who were asked to forgo paychecks for a time period for the good of the company in its initial building stages. With an emergency fund with three to six months’ expenses, you won’t be in danger of failing to cover your bills. Once the paychecks catch up, you will be able to re-establish the emergency fund.

If delays in income extend longer than six months — personally, I would only accept this from an employer for a month at most, if at all — it is time to find a new job, if possible.

Sudden relocation. Usually, if your employer determines that your job should move from New York City to Ogden, Utah, they will compensate you for your relocation. That isn’t always the case, and your option may be to forgo opportunities within your company and business by quitting your job or accepting the relocation and the accompanying expenses. The decision is personal, but it’s better to be prepared to face the consequences.

What does not qualify as an emergency?

I’ve heard of people using emergency funds for expenses that are clearly not emergencies. While everyone’s definition of an emergency is different, if you want to make the best use of your money, I would suggest not tapping money earmarked for emergencies for these expenses. That said, you can save separately for these expenses.

beachVacation. It’s great to get away from your daily responsibilities for a time, but even if your therapist recommends an immediate vacation, you shouldn’t dip into the money set aside to cover emergencies.

A buying “opportunity” in the stock market or real estate. If you’re interested in timing the market or want to buy a house for the fun of it, save separately for the occasion. Most people overestimate their ability to time the market and could find themselves on the losing end of an investment at the moment they need the cash for a true emergency.

Out-of-town visitors. You just heard your friend from college would be in town for a weekend, and she’s suggested getting together for an evening out. If you don’t have extra cash flow at the moment, you might want to suggest a frugal option. Don’t feel you have to impress her by going to the fanciest restaurants and clubs, particularly if you have only your emergency fund available.

Mid-life crises. Recently divorced and quickly aging? It’s time to buy a convertible sports car. That seems to be the accepted path, but it can be a dangerous road to travel, particularly if your ex-wife has half or more of your money. Don’t dip into your emergency fund to buy a new sports car just because you want to feel young again. It may, however, be time to get together with an old college friend for an evening out.

Keeping up with the Joneses. The Joneses buy what they buy because they have no problem with debt. If you’re conscious about spending, you’ll never keep up with the Joneses in the accumulation marathon, nor should you feel the need. They’ve added a sun room and an in-ground swimming pool, but for all you know, they could be paying for it for years. Resist the temptation to match or exceed appearances, whether with debt or by tapping the emergency fund.

What do you think?

I’m sure there are many emergencies and an infinite number of non-emergencies I’ve neglected to mention. I will also bet the total of my emergency fund that some readers will disagree with some of my classifications. (Gambling: not an emergency; Paying your bookie: possibly an emergency.) Please share your thoughts.

Photo credits: au_tiger01, daveynin, and rayced

Updated September 17, 2011 and originally published August 18, 2008. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 12 comments… read them below or add one }

avatar Evan

Flexo,

Question for you,

I am in a situation where I have a good amount of liquid dollars, but also have a good amount of debt. In an effort to eliminate the debt I stopped saving for my emergency fund (i probably have 2 months or so, but REALLY want 6 or so months) and then combined your debt avalance and the debt snowball attacking the debt with all free dollars.

Do you think this is a good call, or should I split it down the middle? or build MY emergency fund the way I want first? Any info would be great…

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avatar Luke Landes ♦127,435 (Platinum)

Evan: I’m no expert so this is just my opinion based on the limited information. Having two-months’ expenses in your emergency fund puts you in a good position to focus on your debt, particularly if you feel you can recover from an emergency quickly. It’s always a balancing act when you’re eliminating debt at the same time as building an emergency fund. It’s better to build a small cushion first, as you’ve done, then attack the debt and fill out the emergency fund when possible. A lot depends on the amount of debt, the interest you’re paying, and your aversion to the risk of lack of income.

Good luck!

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avatar Ryan

When we were building our emergency fund we had a very similar discussion. To us, most situations warranting tapping should be an uncontrollable sudden event or situation that we couldn’t plan for and thus, in order to avoid the assumption of debt, emergency fund cash should be used. It is also a stupid tax buffer and provides a shield as we learn how to adequately plan and navigate the beginnings of our life financially.

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avatar Yana

I agree that job loss and surprise tax bills are valid emergencies, as well as certain medical/death expenses. But one should try hard to find a way around the latter, by trying to minimize those expenses and finding a different way to get them paid. Car repairs or replacement are another valid emergency.

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avatar KC

I think it depends on the depth of your emergency fund as to what constitutes an emergency. Surely if you barely have a month its going to take one helluvan emergency to use that money. If you have 4 months saved up you might be much more willing to use that money when the fridge breaks down or some other minor emergency.

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avatar Brad

I agree with Yana… I ended up having to get surgery about a year and a half ago, out of the blue… it was nothing crazy, but ended up costing me about $4000 after the insurance paid its part. I could have blown away the whole amount over a few months or drained the emergency fund, but decided to make smaller monthly payments. So I called the hospital, worked out a payment plan and have been paying it interest free and penalty free for the last year. In 2 months it’ll all be paid off and I was still able to put money away in savings and not kill the emergency fund in the process.

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avatar Evan

@KC,

I couldn’t agree more…if/when I have 6 or more months of cash built up, something as simple as an unexpected dinner could give me the permission I need to invade it…with the knowledge that I will have to start weekly additions again.

Also another question for everyone out there, What do you do with the income thrown off of it? Currently, I am using all interest towards debt, but was curious what others were doing.

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avatar mppaul2

Well, my modem died this weekend and considering I work from home two days a week, that definitely put this act in the emergency column…so off to best buy I went to pick up a new $100 modem and I’m back up :-)

I did put it on my AMEX Gold, but that’s a for sure pay off with emergency funds in 30 days.

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avatar The Money Answer Guy

Interesting light shed on what constitiutes as an “emergency” in order to withdraw from your emergency fund. I think most people have different outlooks on what constitutes as an emergency, which is why some people can actually maintain and contribute to an emergency fund on a consistent basis. I think a lot of people struggle with the amount of money that should be socked away into an account in the event of an emergency.

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avatar Jason Beck

I tend to play devil’s advocate, and I apologize if it seems offensive :)

But I think your post really only touches on the obvious ends of the spectrum. What really needs light shed on it are the areas in between that are less obvious. My recent example was that my aging air conditioner/heat pump gave out. Repairing it was risky because the whole system could’ve failed in another year and I’d still need to pay for the replacement. Adding to the complexity was that one room was using a thirsty window unit but I could get vents installed along with the new unit for a small additional fee. And with electricity rate caps coming off in the next couple of years, the much more efficient modern unit will save money over the older unit. But all that aside, to pay for this unit, the money had to come from somewhere. And, in fact, it was really more than my emergency fund!

For me, I found it made sense to refinance the loan on my 1 year old car, increasing the loan from $6000 to $10000 at 3.49%.
The electricity savings have already been quite apparent (and a renter of mine agreed to pay $50 more per month now that his room doesn’t have a noisy window unit.) I quickly restocked my emergency fund with $1000, but because I’m an optimist that likes to believe that one big expense isn’t likely to be followed with another unexpected one I wasn’t too worried during the few weeks that it was empty.

Anyway, I’d like to see more ideas and examples of things that may not qualify as an emergency. (Really, I could’ve gone without AC for a while, though going without heat might have been a bit more problematic!)

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avatar qwelikablob

Most things needs maintainance and eventual replacement at some time, but that can be planned for by putting some money regularly into a savings account. I think that using an emergency fund as a maintainance fund for predictable expenses is defeating the purpose of the emergency fund.

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avatar Mike

There’s a pretty simple rule of thumb: if you’re going to call it an “emergency fund,” then you should have absolutely the most restrictive possible definition of “emergency.” Otherwise, you’re kidding yourself.

So long as you maintain an absolutely rigorous, restrictive, narrow, conservative definition of “emergency,” it’s perfectly okay for us to agree to disagree on specifics.

Then again, there’s another solution that I prefer. I refuse, simply as a matter of good practice, to spend more than 40% of my income each month. And in a true emergency, I could cut back. Generally speaking, whatever is left from last month’s paycheck is automatically a 1-month (minimum) emergency fund; and unless I were to suddenly lose my income stream effective a month ago, next month’s paycheck would cover at least a couple more month’s of expenses. This kind of set-up is hard to work out overnight, but if you plan well there’s no reason you can’t get there within 4-6 years. And it really does make life a lot less stressful.

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