Here is a question from a reader:
I’d be interested on a post about what to do after you’ve dipped into your emergency fund considerably. How quick should you replenish it? What are the best ways to replenish it? Is it worth backing off on funding things like Roth IRA’s to build back your emergency fund? It seems like everyone talks about getting an emergency fund, but I haven’t seen many thoughts about what to do after a real emergency.
First of all, it’s good to hear that everyone talks about the emergency fund. Having several months’ worth of expenses easily accessible is a good starting point for anyone trying to get their financial house in order. The funds can be in pure cash, a high yield savings account, a Roth IRA, or any combination of those three. If you have good credit, you may decide that a credit card that offers 0% APR on purchases can assist. Cash in your mattress (or a safer physical location) is the most liquid, but you do want your money to earn some income, so find a balance that works for you.
Just don’t touch the funds unless you experience a real emergency. Buying a new high definition television does not constitute an emergency, but unexpected hospital bills do. Taking a spontaneous vacation to Vienna should not signal a dip into emergency funds, but the loss of a job and therefore the ability to buy food or pay your heating bill might.
When you do have an emergency — a real emergency — you’ll thank yourself first for creating the emergency fund and then for not already depleting it for a non-emergency. When this emergency does occur and your fund is reduced to zero, once the situation has passed, it will be time to start replenishing the account.
If you pulled out your contributions from your Roth IRA for the emergency, which you can do tax and penalty-free, this is probably the first account you’ll want to replenish. This is simply because there is a deadline; after the tax due-date, usually April 15 of the next year, you won’t be able to replenish this year’s Roth IRA contributions.
The next priority would be any debt you might have incurred thanks to this emergency. Even while replenishing your Roth IRA, you should be paying at least the minimums towards your debt, but once you have taken care of any time-limited obligations, pay off that debt at full speed.
Assuming that you are receiving income at this point, automate your emergency savings to get your cash cushion back to its previous level.
How long should the process of restoring your emergency fund take? That’s going to depend on a number of different variables. Not all emergencies are created equal. If you require major surgery or an extended hospital stay and insurance doesn’t cover the expense, it might take a year to refill your accounts if you can return to work. If you can’t work after your hospital stay, it could take much longer.
In fact, if your emergency has changed your life so much, you’ll have more to worry about than just your emergency fund. At this time, you may find yourself forced to reconsider expenses you’ve always found affordable, if not just necessary. Cable television, internet access, eating out or purchasing enjoyable groceries for cooking, and basic entertainment may be eliminated. With fewer monthly expenses, you won’t have to replenish your emergency fund to the previous amount.
Even as you’re getting back on your feet, a 5% automatic deduction from your paycheck into savings can go a long way to improving your safety net. As you find yourself improving your position, increase that automatic deduction.
If you have any more suggestions for what to do after a real emergency, feel free to leave them here. I have not yet experienced a true emergency since creating an emergency fund, so I have no first-hand experience. I’d like to hear from anyone who has been through an emergency.
Note: There are some people who buck the trend and recommend not carrying an emergency fund of some sort. They are counting on never having an emergency or relying on credit (or generous friends or family) to get them through a rough time. They may never have an emergency, but it’s a dangerous proposition for which they could end up paying for years — much longer than if they simply took 3 to 6 months’ worth of expenses out of their high-cost investments and set it aside. This is not the type of risk that is good for long-term investing portfolios. With high interest rates for savings accounts, it’s really not such a bad idea to an emergency fund at least partially saved at HSBC Direct or a similar bank.
Photo credit: frumbert
Updated April 13, 2016 and originally published July 11, 2007.
{ 6 comments… read them below or add one }
I agree Flexo. Also I suggest saving in side-accounts for any big ticket purchases you are planning on making (car, house down payment, etc.) in order to avoid tapping your emergency fund except in a REAL emergency.
We’ve been through an emergency a couple of times. My husband is in sales, which isn’t the most stable career. In May he lost his job. He’s back at work again, but on commission, and we’re supplementing with our emergency fund until his sales get going.
You’ve given some great advice. My addition to that advice would be to try to cut living expenses as soon as the emergency hits. Be as frugal as you can until you’re through the emergency AND have your emergency fund replenished. you never know when you’re going to need it again. We’ve had to use ours twice in the last 3 years, and I’m glad we had it. We would have had to turn to credit cards without our fund.
I’m not sure you entirely answered the reader’s question…You seemed to skirt around and towards it, but I’m not sure you offered an actual answer.
As I read it, the main question is this: “Should one reduce contributions to retirement savings to replenish an emergency fund?”
To that I say, if the fund was reduced less than 50%, change nothing. Once the emergency has passed, continue your standard monthly contribution and allow that to rebuild the fund. If the fund was reduced by MORE than 50%, especially all the way to 0, or even into debt, then things become a bit trickier.
If it were me, I’d trim my non-retirement savings (separate from emergency fund savings) first, as well as seeing if there were any unnecessary expenses. If that still isn’t getting you much, then I’d reduce 401k contribution down to the level that gets full company match (if you’re higher than that). Finally, if THAT isn’t enough, then and only then consider reducing the amount you contribute to your Roth each month until your emergency fund has recouped a little.
I agree, i don’t think the original question was answered.
you should replenish the emergency fund as quickly or as slowly as you think fits within your budget. remember, the emergency fund allowed you to get through the emergency without having to take on more costlier options.
i don’t think there is a universal formula for replenishing the emergency fund; however, i would say that you want to maintain beneficial savings first when determining to cut back other savings in order to replenish the fund. that is, if you have matching 401k, then contribute up to the max for matching contributions. look at other areas to trim from like ira’s or investments. you’ll have to readjust your investment timelines and budget in order to accommodate for replenishing the emergency fund, though.
I didn’t outright answer the question straight out because in my opinion there is no simple answer. If you don’t invest in your Roth IRA, then you will miss out on tax-advantaged investments for the year. With the fact that you can withdraw your Roth IRA contributions without any tax or penalty, you can in effect use that account as part of your emergency fund, so it’s not a one-or-the-other (Roth IRA or emergency fund) situation.
If you don’t invest in your 401(k) up to the match, you could be missing out on a 50% or higher immediate return. That kind of opportunity is almost “too good to be true.” You must take advantage of this, even before your emergency fund is complete. If your 401(k) does not have a matching program, it’s more wise to focus on your emergency fund.
Any other advice can only take into account an individual’s particular situation post-emergency. “Trimming your expenses” only works if expenses aren’t already trimmed to the bone. As Tim said: “You should replenish the emergency fund as quickly or as slowly as fits within your budget…” but that isn’t any more of a concrete answer than what’s been presented.
The best answer to many financial questions is, “It depends…” except when it doesn’t. :>
Rather than strive for a set 3 months’ living expenses, I’ve decided to “self-insure” by putting a set dollar amount into my emergency fund. So, even if I only need $6000 for 3 months’ expenses, I’ll keep contributing a fixed amount so I don’t ratched up spending once I hit a particular target for that account