There are expenses in life that you just don’t see coming. That’s why you need an emergency fund.
An emergency fund is one of the basic building blocks of financial stability and an important part of your financial plan.
If you had a $400 unexpected expense tomorrow, could you cover the expense with cash? If not, it’s time to start building an emergency fund.
With an emergency fund, handling an unexpected major expense is less of a burden. You also get peace of mind knowing you can handle whatever emergency situation or unplanned expense comes your way financially.
Without emergency savings, a financial emergency might lead to credit card debt, high-interest loans, or even bankruptcy. Being unprepared for an unexpected emergency threatens your financial security. Keeping you financially stable during costly unexpected events is what an emergency fund can do for you.
As a rule of thumb, most experts suggest having 3 to 6 months of expenses set aside in case of emergencies if you have a consistent income. Your monthly income inflow might fluctuate if you are a freelancer, contractor, or work on commission. Having 8 to 12 months of living expenses saved might be more prudent if you have an irregular income.
What Are Emergency Funds Used For?
An emergency fund consists of cash reserves you set aside to use only in financial emergencies and for unplanned expenses. Some common emergency fund uses included unexpected medical bills, unplanned home repairs, auto repairs, or a sudden job loss.
Here are more examples of what an emergency fund is used for.
Emergency Fund Examples
In case you’re wondering when to use your emergency fund, here are 10 emergency fund examples that illustrate what emergency funds are used for and the types of expenses you might face:
1. Job Loss
Whether suffer a layoff or you voluntarily leave your job for personal reasons, an emergency fund provides you with a cushion. If you find yourself out of work for whatever reason you’ll have a safety net to tide you over until you can find another job.
If you live paycheck to paycheck or don’t have any emergency savings, a sudden loss of income can be financially devastating. A 3-6 month emergency fund can get you through it without making your financial situation worse. A larger emergency fund is a good goal if your main source of income is less stable.
2. Pay Cut
Companies reduce wages, cut hours, or eliminate bonus programs when they’re not doing well. You might be forced to choose between taking a salary reduction or being let go. If you work for yourself, you might lose a big client or have a customer not pay you.
If you accept a pay cut from your employer, finding a better job opportunity is tough. Your availability for searching, preparing, and interviewing is limited by your current job.
Your work still requires the bulk of your time and takes up your energy. Your employer still expects a commitment from you. You are still accountable for meeting performance standards.
It’s still a stable income with a regular paycheck. It just isn’t what it used to be. You might not make enough to cover essential living expenses anymore.
A pay cut is incredibly hard to handle emotionally and financially. You can at least soften the financial hit with your emergency fund.
3. Medical Emergencies
When you’re young, you feel invincible and tend to take your health for granted. Sooner or later you realize medical emergencies can happen to anyone at any time. Medical emergencies threaten your health and your cash flow.
Medical care is not cheap. Getting treatment or being hospitalized is wildly expensive for common injuries and procedures that are not life-threatening. Emergency medical care is even more costly.
Despite having health insurance, you might have to cover some of your medical expenses yourself. If your medical emergency involves an ambulance ride, a trip to the emergency room, unplanned surgery, or ongoing physical therapy you might be paying for some or all of the cost yourself.
4. Moving for Work
My husband and I have moved for work three times over the years, twice for his job and once for mine. We’re both originally from the New England area where we met, but have lived in Montana, New Jersey, and Georgia, where we live now.
One employer gave us a one-time payment upfront to cover moving expenses. The other two reimbursed us. All three times we came out well behind.
Not every employer offers relocation assistance so we were lucky in that regard. But we never really got the full amount of our moves covered. The costs add up fast, our relocation allowances were capped at a certain amount, and there are so many additional expenses.
For example, we didn’t pack our dirty old mop and we didn’t have enough lamps for the new place in New Jersey. That first shopping trip upon arrival ended up costing us around $300. We bought shelving, cleaning gear, floor lamps, and random little things like ice trays we didn’t bother packing or didn’t realize we would need.
When we moved to Georgia, we rented an apartment while we looked for a house. When we first looked at the place, there was a refrigerator in the kitchen. When we moved in, it was gone.
We didn’t notice that buried within the terms of our rental agreement, in the section that spelled out which appliances were included, the refrigerator box was unchecked. We bought a used one off of Facebook Marketplace, but that was not a reimbursable or expected expense.
Whether your employer reimburses you, pays you upfront, or handles the move for you, there will probably be some out-of-pocket expenses. It could be something little, like a random household item you forgot or it could be substantial, such as a housing deposit or refrigerator.
Obviously, with reimbursement, you’re burdened with paying moving costs yourself at first. You save your receipts, get your expenses approved, then wait who knows how long before you see a dime.
Even with a generous relocation package, you might end up paying for new furnishings, utility deposits, extended hotel stays, or other things that aren’t fully covered. If things don’t work out and you end up moving back in less than a year or two, you could be on the hook for paying back some or all of the relocation money you received.
5. Surprise Cost of Living Increases
I once had a roommate move out with no notice. She never told me she was leaving, where she was going, or why. I got home one night and she was just gone.
My landlord was OK with me only paying my half of the rent until I could get a new roommate. That could’ve gone another way, which would’ve thrown my life into utter chaos. My utility payments instantly doubled, though.
I managed to fill the spot in about six weeks after calling everyone I knew. It was really hard for a while because I didn’t have the buffer from emergency savings. I lived on ramen noodles, raisin bran, and other super cheap foods for a month.
Rent and utilities typically only increase over time and are subject to large jumps. If you have an adjustable-rate mortgage, your mortgage payment could increase significantly. An emergency fund will buy you a little time for figuring out your next move when your monthly expenses increase unexpectedly.
6. Unexpected Necessary Travel
If you lose a loved one, worrying about unplanned travel expenses or how you’re going to pay for them just adds to your grief. You don’t want that to make a stressful situation worse.
Funerals aren’t the only reason you might travel at a moment’s notice. You could have other far-away obligations, important milestones, and family members falling ill.
Sometimes an important life event is scheduled months in advance. Others require a last-minute flight. You might not have the cash on hand to travel, which is where your emergency fund comes in.
Last-minute travel is expensive. If the people you love count on you to be there in their time of need or to take part in the most memorable days of their lives, you should prepare for the cost of the travel involved.
7. Car Repairs
We rely on our cars to be our primary mode of transportation. We need them to get to work and take care of our families.
Unfortunately, anything with moving parts is going to break eventually. And a car is a rather large collection of very expensive moving parts.
Even if you have the maintenance done on a regular basis, brakes wear out, transmissions need repair, and engines fail. Unexpected car repairs can strike a major blow to your cash flow.
Aside from mechanical failure, there are accidents, potholes that can cause a flat tire, and unforeseen events. A tree might fall on your car during a storm. Or a drunk driver with a suspended license and no insurance could slam into your parked vehicle after a police chase.
Insurance might cover the cost of repairing some or all of any damage related to an accident. But you might have a high deductible. That makes you responsible for coming up with a good bit of cash yourself when you face a major repair and want your car back on the road.
Or you might not want to involve your insurance company. You might fear increased premiums or worry about getting dropped by your insurer. Settling without your insurance company is risky, but if you’ve thought it through and you’re going to do it, coming up with the money might require dipping into your emergency funds.
Regardless of the circumstances, car repairs are expensive. You could be looking at a few hundred to a few thousand dollars for your next unexpected car expense. If you rely on your car, you need money set aside for emergencies.
8. Home Repairs
Homeowners insurance covers many unexpected home repairs, like a roof that starts leaking. If you have a high deductible, coming up with the out-of-pocket costs required for an unexpected major home repair might be tough without emergency savings.
There are plenty of expensive things your policy will not cover as well. Most homeowner policies don’t cover a costly repair to your water heater, but any damage from leaks or ruptures might be covered depending on the terms of your policy.
For another example, a few years ago, a couple of huge trees were uprooted and fell across our driveway during a wicked storm. Luckily, our cars and home escaped damage. Since nothing insured was damaged, the roughly $1,400 tree removal and the cleanup bill were on us.
9. Family Emergencies
If we had a family motto, it might be, “Wow. Didn’t see that coming.”
You might need to tap into your emergency savings for emergencies that are not technically your own. Sometimes your family members find themselves in situations where they need help and it’s up to you to provide it. It could be anything from tuition assistance to bail money to elder care or emergency pet care.
I’ve taken unpaid time off under the FMLA (Family Medical Leave Act), which offers you job protection for up to 12 weeks, to care for a sick relative. That turned into a long sabbatical and me having to re-apply for my old job.
It was one of the worst times for us financially. We never would’ve made it through living on one income without a contingency fund for emergency use only.
10. Unexpected Tax Bills
Completing your taxes is stressful enough. Finding out you owe money when you weren’t expecting to is scary and panic-inducing.
You could owe money for a variety of reasons. It could be due to tax code changes, having too little withheld from your paycheck, underestimating your quarterly self-employment taxes, or generating income from a non-wage income source.
Regardless of the reason you owe taxes, the last thing you want to do is avoid filing a return. Interest and penalties pile up. The government can garnish your wages or seize your assets.
You could also go to jail. Playing cat and mouse with the IRS is a terrible idea.
File your tax return on time. Pay as much as you can.
You can ask for a payment extension or enter into a repayment agreement. Neither of those things is guaranteed, however, meaning the IRS can say no.
With a monthly payment plan, you pay a fee to set it up and interest until your debt is paid off. If you’re eligible for a tax refund in future years, your tax refund will automatically go toward your IRS debt.
I would consider owing money to the government money a true emergency. If I found myself in that spot, I would crack open my rainy day fund or tap my emergency savings to clear it. I would rather do that than have another monthly payment and the IRS hanging over my head.
What Your Emergency Fund Should Not Be Used For
Can you dip into an emergency fund to pay for a vacation, holiday gifts, or some other nonessential expense? There’s nothing stopping you from doing that, but it’s not a financially sound idea.
An emergency fund should not be used for discretionary expenses or essential living expenses. Limit your emergency fund uses to actual emergencies no matter how tempting cracking it open might be.
An emergency fund should be deposited in a separate interest-bearing bank account, not in stocks or mutual funds, to be used only for unanticipated expenses. The money is kept separate from the money you use for your basic living expenses so it’s there when critical expenses come up.
You can’t see the future, but you can bet you’ll encounter surprises and unforeseen situations in life. Having a rainy day fund in the bank separate from the money you use for daily living expenses can keep your finances stable when those unplanned situations arise.
You won’t have to turn to worse options like high-interest credit cards, taking out a loan, or tapping into your retirement funds. You won’t have to suspend progress on your financial goals or sacrifice your future security while you dig yourself out of a hole.
You don’t want an unexpected hospital bill, an emergency home repair, a pet emergency, or any common emergency expense putting your financial future in jeopardy. Prepare by having emergency money set aside. Make building your emergency fund a priority, so when you have an unexpected emergency pop up, you’re ready for it.
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