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Life is unpredictable, but that doesn’t mean you have to let chaos run your life. There are proactive measures and countermeasures you can put in place to minimize your potential risks. It’s no surprise that money plays a huge role in managing risk. Today, we’re here to talk about the power of a well-managed emergency fund and how you can take steps to estimate how much you will need and how you will reach that goal.
Reasons Why You Need an Emergency Fund
Handling an unexpected significant expense is less of a burden with an emergency fund. You also get peace of mind knowing you can manage whatever emergency or unplanned expense that 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 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 personal finance experts suggest setting aside 3 to 6 months of expenses 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. Saving 8 to 12 months of living expenses might be more prudent.
What Are Emergency Funds Used For?
An emergency fund consists of cash reserves you set aside to use only for financial emergencies and unplanned expenses. Some common emergency fund uses included unexpected medical bills, unplanned home repairs, auto repairs, or a sudden job loss.
Read on for more examples of emergency expenses and 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 unplanned expenses you might face:
1. Job Loss
An emergency fund provides a cushion whether you suffer a layoff or voluntarily leave your job for personal reasons. 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. That so-called recession-proof job could be gone without warning.
A 3-6 month emergency fund can get you through it without worsening your financial situation. A larger emergency fund is a good goal if your primary 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 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.
Finding a better job opportunity is tough if you accept a pay cut from your current employer. Having the time to search, prepare, and interview is limited by your current work schedule. Your job requires the bulk of your time and plenty of 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 tough to handle emotionally and financially. You can at least soften the financial hit with your emergency fund until you find a better employment opportunity.
3. Medical Emergencies
When you’re young, you feel invincible and take your health for granted. Sooner or later, you realize medical emergencies can happen to anyone anytime. This type of emergency can seriously 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, or other services not covered by your insurance.
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 we 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, the cost of moving was more than the stipend we received. Not every employer offers relocation assistance, so we were lucky. But we never really got the total amount of our moves covered. The costs add up fast; our relocation allowances were capped at a certain amount, and there were many additional expenses.
Our 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; the refrigerator box was unchecked in the section that spelled out which appliances were included. We bought a used one from 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 minor, like a random household item you forgot or substantial, such as a housing deposit or appliance.
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. Without an emergency fund, this situation could be even more stressful for many.
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 half the rent until I could get a new roommate. But had my landlord not been so generous, it could have thrown my life into utter chaos. Even with the relief on rent, my utility payments instantly doubled.
About six weeks after calling everyone I knew, I managed to fill the spot. It was tough 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 increase over time and are subject to large jumps. Your mortgage payment could also rise significantly if you have an adjustable-rate mortgage. An emergency fund will give you time to figure 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 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, a significant life event is scheduled months in advance. Others require a last-minute flight. You might not have the cash 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 costly moving parts.
Even if you have the maintenance done regularly, brakes wear out, transmissions need repair, and engines fail. Unexpected car repairs can strike a significant 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 generating a lot of cash when facing a significant repair.
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 costly. You could look at a few hundred to a few thousand dollars for your next unexpected car expense. If you rely on your car, you need money 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 unanticipated 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 giant 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 savings for emergencies that are not technically your own. Sometimes, your family members find themselves needing help, and it’s up to you to provide it. It could be anything from tuition assistance, bail money, 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 became a long sabbatical, and I had 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 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. However, neither is guaranteed, 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 as an actual 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 gift, or other nonessential expenses? Nothing stops you from doing that, but it’s not a financially sound idea.
An emergency fund should not be used for discretionary 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 funds you use for basic living expenses, so it’s there when critical expenses arise.
You Know the Reasons You Need an Emergency Fund
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 don’t want an unexpected hospital bill, an emergency home repair, a pet emergency, or any emergency expense jeopardizing your financial future. Prepare by having emergency money set aside. Make building your emergency fund a priority so that when an emergency pops up, you’re ready for it.
