Your Emergency Fund: What Qualifies as an Emergency?
An emergency fund is the cornerstone of good financial management, regardless of which personal finance guru you listen to. A small emergency fund of a few hundred to a few thousand dollars can make all the difference when you’re trying to make steps to become financially independent.
Saving your emergency fund in a high-yield savings account. Ideally you won’t have to tap into your emergency fund at all, but there’s a reason you’ve got that money saved. Planning ahead can keep you from going into more debt if you’re trying to become debt free. Or it can help you make better financial choices out of a place of security rather than scarcity.
But here’s the thing: an emergency fund doesn’t do you a whole lot of good unless you can adequately define what is and is not an emergency. So before you save your first dollar in that emergency fund, think through what constitutes an emergency for which you’ll tap into your fund. (If you’re married, be sure you have this conversation with your spouse, too!)
Defining an emergency ahead of time will help you keep your paws out of that money in occasions that feel like emergencies but really aren’t.
Legitimate emergencies
Sudden job loss. For most people, the primary source of income, and thus the ability to pay for expenses, is a job. Most people aren’t entitled to a severance bonus in the event of sudden job loss, which means that paying bills could quickly become impossible after sudden job loss.
One part of preparing for such a situation is to take diversify your income and to always being prepared for job loss. Having an emergency fund is a big part of this preparation. An emergency fund that covers a few months’ worth of expenses can help you weather the storm while you find another job.
Ideally, your emergency fund would cover six months’ worth of expenses or more, giving you plenty of padding in the event of job loss. But you may not need quite this month, especially if you’re living in a two-income household where one spouse’s income can cover most or all of the essential expenses.
Regardless of the size of your emergency fund, sudden job loss is an acceptable time to tap into that fund to pay expenses that are essential while you work on getting another form of income.
Death or medical emergency of a family member. Life insurance can certainly help deal with the death of a family member, especially when it comes to funeral and end-of-life expenses. But these policies can take time to pay out, and they may not cover your family’s additional expenses in the event of an extended family member’s death, including travel expenses.
If your parents or other close family members are aging, it may be a good idea to set aside money specifically for such expenses. But if one of these events occurs before you’re prepared, you can tap your emergency fund to meet necessary expenses.
Acts of nature. When it comes to protecting your home, car, and other personal possessions from natural disasters, having the right insurance coverage is essential. For instance, if you live in a hurricane-prone area, you may need flood insurance, even if you’re not technically in a high-risk flood zone.
The fallout of Hurricane Katrina was a prime example of the importance of the right kinds of insurance, as many New Orleans residents thought their insurance would cover their homes when it really didn’t.
In cases like this, an emergency fund probably won’t cover rebuilding your whole life. But it could prevent you from going into debt when you have to flee your home for a time and stay in a hotel, pay for flights, or incur other emergency expenses.
Car 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 needs to at least cover your deductibles, but should also fill in any gaps left after payments arrive.
If you don’t absolutely have to have a car–like if you can use public transportation to get to work and the grocery store–you may not want to tap your emergency fund to help pay for a new vehicle. But if you must have a vehicle, a new-to-you car could be a legitimate use of your emergency fund.
Essential work expenses. Some expenses that may not seem like an emergency to others could be if you require certain things to get your work done. For instance, if you work from home and your internet goes out, you might have to dip into your emergency fund to pay for a new modem so that you can keep working to bring in an income.
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 can re-establish the emergency fund. An emergency fund in these situations can help you pursue dreams with new or non-profit companies, though you shouldn’t accept employment at a place that regularly delays its employees’ paychecks.
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 nice to have an emergency fund that can at least give you the option to pick up and move should an unexpected offer arise.
Unexpected home repairs. Regular repairs on your home should be a part of your overall budget. But sometimes the unexpected happens. A washer or dryer goes kaput. Your fairly-new roof starts leaking. Or your heat goes out in the middle of winter.
It’s important to look at these situations individually so that you can determine if they truly are emergencies. If you have a large family and live in an area without laundromats, a washer going out may truly qualify as an emergency. But if your air conditioner goes out in the summer, you could most likely live without it until you save enough money to fix the problem.
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.
Certain medical emergencies. Sometimes medical emergencies justify tapping the emergency fund. Even after insurance is applied, a minor surgery can cost thousands. But before you pay it off with emergency funds, talk to the medical provider or hospital. Often, you can put your balance on a payment plan and pay it off interest-free. If this is the case, choosing interest-free payments may be better than draining your emergency fund.
Vacation. 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.
Ultimately, It’s Personal
Some people are likely to disagree with me on this list, and that’s okay. Ultimately, deciding how to spend your emergency fund is personal. And it also depends on how much emergency fund you’re dealing with.
If you have a six months’ worth of expenses in the bank, you might pull $1,000 out to buy a new washing machine when yours breaks down. After all, you need to get laundry done, and that is a drop in the bucket compared to the account’s total balance.
But if you only have $1,000 in the account and your washing machine conks out? Consider schlepping your laundry to your mom’s for a couple of months while you save up for a used washing machine from Craigslist to replace it!
Photo credits: au_tiger01, daveynin, and rayced
Article comments
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.
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.
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!)
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.
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.
@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.
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.
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.
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.
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.
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!
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…