Personal Finance
An Emergency Fund: How To Make One & Alternatives
Life can be unpredictable, and unexpected emergencies happen. One of the best ways to offset surprise financial burdens is to regularly save money to help cover them. Learn how an emergency fund can help you plan for the future and improve your overall financial wellness.
What is an emergency fund?
An emergency fund is a cash reserve that’s intended to be used for unexpected situations. The money you save in an emergency fund can help offset costs that can come up, such as a surprise medical bill or expensive home repairs. Having an emergency fund could reduce the need to use credit cards or loans when you’re faced with unforeseen expenses.
How much should you have in an emergency fund?
The amount you should have saved in an emergency fund will depend on your financial circumstances. There’s no exact amount, but as a general rule of thumb, your emergency fund should be enough to cover three to six months’ worth of expenses.1
How to start an emergency fund
Here are some basic guidelines that can help set you up for success.
1. Make a budget: List out your monthly income and expenses to get a better idea of how much money you have at your disposal. Budgeting helps you organize and manage your finances.
2. Set a savings goal: Once you’ve drafted a budget, you can determine how much you can reasonably save on a weekly or monthly basis. It’s okay to start small. You may be surprised how quickly $10 or $20 a week can add up. Try to stay consistent and save regularly. After reaching your initial goals, consider incrementally setting them higher.
3. Automate your savings: Setting up automatic, recurring transfers to your savings account is a great way to start building up your emergency fund. If you get direct deposits through your employer, you may be able to split it between two accounts to automatically set aside funds for savings. You can also set up automatic transfers with your bank or use an app to regularly schedule contributions.
4. Try to only use funds for emergencies: While the occasional dip into your emergency fund for non-emergency situations may be okay, you should ultimately strive to only use it when you need it most.
5. Monitor your progress: Plan to regularly check your budget, goals, and spending habits to ensure you’re staying on track. Try using a financial wellness app to better help you manage and monitor your money.
Emergency fund alternatives
In addition to an emergency fund, there are other ways to help safeguard against crisis situations and unexpected expenses.
A good financial plan may include some or all of the following:
Rainy-day savings account
Like an emergency fund, a rainy-day savings account is also meant to cover unforeseen expenses. The difference is that a rainy-day saving is typically smaller than an emergency fund, as it’s meant to be used toward one-time or short-term costs. You may also consider opening a rainy-day fund for more routine, but expensive, expenses, such as veterinary bills, regular car maintenance, and phone repairs.
Supplemental health insurance
While not a type of savings account, supplemental health insurance can help you pay for medical costs that your primary health insurance provider may not cover. Typically, these plans can help cover unexpected expenses related to illnesses and accidents with a lump-sum payment.
Retirement plans
Retirement plans aren’t an emergency fund alternative, but are a great way to save for the future, and can help provide some cushion for emergencies. Contributing to an employer-sponsored 401(k) plan can help build financial security after you leave the workforce and allow you to better meet your goals. If you need money right away, some 401(k) plans let you borrow from yourself without taxes or penalties — as long as you follow your plan’s rules and pay the loan back.2 You may also be able to take penalty-free withdrawals from a retirement account if you qualify for an exemption.3
Flexible spending account or health savings account
Both flexible spending accounts (FSAs) and health savings accounts (HSAs) are pre-tax accounts that you can use to pay for healthcare costs. Withdrawals are tax-free if you use them for qualified medical expenses. There are a few key differences, however. To be eligible for an HSA, you need to be covered under a high deductible health plan (HDHP). FSAs are often offered as an employee benefit and don’t require enrollment in a specific health plan. Unused HSA funds can also be carried over at the end of the year, unlike FSAs.