So What Really Counts as a Financial ‘Emergency’?

Gabrielle Karol
Posted

We always say you should set up a budget for financial emergencies, but readers ask us all the time what that really means. Today, we’ve got your answer:

Situation #1: It’s a friend’s wedding, your ex-boyfriend will be there with his new girlfriend and you need an absolutely perfect dress to wear.

Situation #2: A once-in-a-lifetime opportunity presents itself for you to go on a trip to Tahiti … but you haven’t exactly been saving up for a vacation like this.

Situation #3: It’s your best friend’s 30th birthday party, and a mutual friend has suggested that a group of you put in for a present that’s just a little more expensive than you had been planning on (even though you’re only paying a fifth of it).

Emergency Money

Though these three situations might not be life-or-death emergencies, they’re still emergencies, right? Well, not really … at least not where your “emergency fund” is concerned.

Still, while you know that a killer pair of post-breakup stilettos isn’t quite why you’ve been socking away money, it can be tempting to dip into your stash when something comes up that’s not in your budget.

RELATED: The Basics – How to Set Up a Budget

At LearnVest, you’ll hear us talk about your emergency fund a lot, and that’s because it’s the best way to protect yourself in a true monetary crisis. To understand what’s really considered a financial emergency, how much you need to save in an emergency fund and how to prepare for those big expenses that always seem to sneak up unannounced, we asked Brandie Farnam, a LearnVest financial expert and CFP®. Check out her answers:

What’s an emergency fund, anyway?

An ideal emergency fund is at least six months of net income stored in a savings account. LearnVest advises you to have at least six months’ saved, but if your job is unstable or you work as a freelancer and have an irregular income, it’s probably best to have more than that socked away.

When are you allowed to dip into an emergency fund?

An emergency fund should really be used only in the five following situations:

  1. You’ve lost your job, and need to continue paying rent, bills and other living expenses
  2. You have a medical or dental emergency
  3. Your car breaks down, and is your primary form of transportation
  4. You have emergency home expenses—i.e., your A/C breaks down in 100+ F weather, your roof is leaking, your basement is flooded, your toilet is overflowing, etc.
  5. You have bereavement-related expenses, like travel costs for a family funeral

If you don’t have an emergency fund saved, and one of these five types of emergencies arises, you’d likely be tempted to use a credit card to handle it, leading you into credit card debt. In fact, medical expenses are the leading contributor to credit card debt, with low- to moderate-income households averaging $1,678 in credit card debt due to out-of-pocket medical expenses.

What’s worse? Paying for emergency expenses on your credit card, if you don’t pay off your bill immediately, will cost you more, as you’ll rack up interest payments as you try to dig yourself out of debt. Having an emergency fund saved will not only save you more money in the long run, due to the fact that you won’t be paying interest on your expenses, it will give you peace of mind, knowing that you’ll be able to handle whatever life throws at you (and there will be a curveball one day–trust us).

Doesn’t anything else count? What about near-emergencies, like property taxes, freelance taxes or insurance payments?

Property taxes, along with taxes for freelance work, renter’s insurance and homeowner’s insurance—not to mention unexpected taxes come April—are considered “irregular expenses.” They can seem like an emergency—especially if you haven’t saved up for them—because you can’t not pay your taxes or your insurance bills.

That said, dipping into your emergency fund for anything besides the five situations detailed above is a really bad habit—and it means you won’t have enough money should a real emergency pop up. Here’s what you should do instead:

  1. Estimate how much money you’ll need to pay for these one-off or irregular expenses based on how much you had to pay last year.
  2. Divide this estimated number by 12—this amount will be how much you should put away each month. In terms of the 50/20/30 rule (see below for a full explanation), you should think of this money as coming from your 30%, or your lifestyle choices.
  3. Automate your savings so the amount you calculated in step #2 is deducted each month and put it into a savings account separate from your emergency fund.

If you don’t have an emergency fund, what’s the best way to build one?

LearnVest advises you to split your monthly budget using the 50/20/30 rule:

  • 50% or less of your take-home pay should go to essentials like rent, groceries, transportation to and from work, and utilities
  • 30% or less should go to lifestyle choices like shopping, entertainment, going out with friends, etc.
  • 20% or more should go to priorities, like saving an emergency fund, saving for retirement and paying off debts (credit cards, student loans, etc.)

Here’s how you should divvy up that 20% to your different priorities:

  1. Retirement: If your employer matches your 401(k) contributions, pay the minimum amount necessary to get the full company match. If there’s no matching program, save at least 1% of your take-home pay in a 401(k), or start saving $50 a month in a Roth IRA.
  2. If you have credit card debt: Split the remaining amount equally between paying off your credit card debt and stocking up your emergency savings, until you have at least six months saved in your emergency fund. If you don’t have credit card debt: Contribute the remaining amount to your emergency fund, until you have at least six months saved.
  3. Every six months, schedule a 1% increase in your retirement savings contribution if you’re putting it in a 401(k) (or a $50 increase if you’re saving in a Roth IRA), even while you continue to contribute to these other goals.

What should you do if you already have six months saved in your emergency fund, or are nearing that point?

If you have six months saved in your emergency fund, stable work and a regular income, and no debts …

Congrats! Now you can concentrate on tackling other priorities and goals. Consider upping your retirement savings and trying to max out a Roth IRA in addition to your 401(k) contributions. You can also create and start funding savings accounts to pay for other goals like travel, a down payment on a home or a future wedding.

RELATED: When to Set Up a Budget … for Splurges

If you have six months saved but are in an unstable profession …

Consider continuing to fund your emergency fund until it holds nine or more months of living expenses, while still saving for retirement and paying off any loans or debts you might have.

If you have six months saved but have credit card debts or loans …

Now you can start paying down your credit card debts more quickly or contribute more to paying off your student loans. This will help improve your credit score, which will help save you a lot of money in the long run. (Find out why here.)

Trust us: While it might seem tempting to spend “priority” dollars that should be going to emergency savings or your 401(k) on “priorities” like that trip to Aruba with the girls or a bag that will last for seasons, you’ll feel much better knowing you can handle any real emergency that comes your way.

  • Tina Beckwith

    what if you have been unemployed for over two years, are a all-but-dissertation PhD and have applied to any and every job possible? an emergence fund seems like a far off dream….an oasis that will never materialize.

    • gabriellekarol

      Hi Tina,

      In this economy, we know that building an emergency fund (or even paying the bills) can seem nearly impossible, especially for the unemployed or underemployed. 

      Have you taken our Build Your Career bootcamp? We have some really great tips on how to kickstart your career search, as well as ideas on how to increase your earnings (maybe through freelancing?). Plus, it’s free! Hope you check it out: http://www.learnvest.com/how-lv-works/bootcamps/build-your-career/.

      Out of curiosity, what field are you getting your PhD in? 

      -Gabrielle

      • Tina Beckwith

        Thanks  for such a kind response, Gabrielle! Yes, I have taken the Build Your Career bootcamp and every other bootcamp on LV. LV is like my version of FB, but with actual smart things to read!

        My PhD will be in Communications and Native American Studies.

        And, I meant my question earnestly! I am convinced that I can and SHOULD be saving money more than ever! I was lucky that when I got downsized, I had a hefty emergency fund from working my way through undergrad and graduate school. It is dwindling, but I am freelancing as much as possible and have learned the amazing art of bartering.

    • Get A Job Scum!

      If you have been on unemployment for more than six months your a LEECH!!!!
      Get off your lazy A–! and get a job!! You are destroying my country!!!!!!!

      • Canwebenice

        I guess you didn’t finish ready reading the posts. Very sad that some people jump to conclusions about others. I agree that we can’t be lazy about employment. Unfortunately for her, she was just the sounding board for your distain of laziness. In the last part of her most recent post, she states that she is a freelancer. Freelancing is not for lazy people. Takes some leg work.

  • Mgjubblies2003

    These are “true”emergencies. I’m posting them up for a constant reminder as to what and why I started saving for an emergency in the first place. Thanks a million!

  • Guest

    I’m 24, have a job at a nonprofit and making just enough to support myself, pay down my debt & do all the responsible short-term things. I know my next goals are to secure an emergency fund and a retirement fund. I currently have neither. My nonprofit doesn’t offer a match. Where do I start? They’re both really important, but I don’t have a lot leftover for either to happen very quickly. My current idea is to try to save for a 3-month emergency plan (every time I get a bonus or tax returns I put it there), then put a few thousand in for a Roth IRA, and then go back to growing the emergency fund. Does that make sense?

    • Jenna

      If you feel that your job is very stable, then maybe you could build up a 3-month fund, and then split the amount from then on to put 50% to retirement and 50% to continue building your emergency fund.

      • Guest

         That’s a better idea I think- thanks for the advice!

      • No Credit Cards 4 me

        I got a better idea. Start a joint emergency savings plan. $10 from each check. You probably spend way more on weed and booze. So, you and 5 other people, preferably family members or close friends. Five of you each put in $20 per month into an emergency fund. After just one year you’ll have $1,200.00 in the account that you can count on if you have a real emergency. In just ten years you will have big time money in that account and you can roll some of that into a moneymarket account and grow it. That’s what me and my xwife and my three kids are starting.

  • Britt

    It took me a while but I’m almost at my savings goal.  I moved to nyc right after college and took a job for around $25k a year and just tried saving whatever I could.  Setting up even $50/paycheck to be automatically deposited into my savings account made a huge difference (even mentally not seeing the money in my pacheck helped) I put all the extra money I got (gifts, work bonus, tax return, everything!) into savings and when I was comfortable with that then I started having $50/paycheck put into a roth IRA.  It’s slow going (especially with my retirement account) but it builds up over time.  It was especially important for me to think of my emergency fund as money that wasn’t mine.  I pretended that I didn’t even have it as a cushion so that I wouldn’t be tempted to take from it.  It came in really handy when my father was sick and I was able to leave my job for 3 months to be with him.

  • Jenna

    The article makes a good point about things that we know we have to pay (insurance, taxes) that may not get billed monthly. While I wouldn’t consider these “near-emergencies” (you know you have to pay them every year), they can be significant amounts, and I think the recommendation of creating an automated monthly savings transfer into a separate account is a great idea. Some insurance policies will let you set up a monthly payment plan with no extra cost, so maybe that would be an even easier solution.

    • Jess

      I agree! I actually have a specific checking account for these items and am signed up for automatic payment plans, so I am both putting money into them through direct deposit and letting the money go out of them automatically for the things I need to pay. Of course, I am keeping close track of the charges to make sure I put in enough and that I’m not being charged for ridiculous things. It’s become a great system for me!

  • James

    Do you have suggestions for someone who’s ‘priority payments’ are well above the 20% mark not including savings or an emergency fund? I’m 25, a recent grad with a bachelors degree (and the loan payments that come with) I love my job but working for an independent business means my pay is comparatively low. (Luckily they give me a wardrobe allowance!) My rent alone is 20%-30% of my income. I just calculated my loan/creditcard/remaining tuition payments and they come to 40% of my take home pay. Should I be bringing those down to minimum payments in order to create an emergency fund as well? 

  • Frustrated

    What about divorce expenses? Or, as is the case for me now, an ex-husband who drags you back to court whenever he can because he has lots of money to do that (he has been able to hide hefty amounts of income- etc.) and I literally live paycheck to paycheck (though I do have a small emergency fund set aside)? Do you tap into the fund to pay lawyers fees, court costs etc.? I spent almost all of the money I had (except for the small amount still in my emergency fund) on divorcing him (close to $200,000.) and my salary is not that great. I have tried to figure out ways to make a better living financially, but being a single mom with three young kids limits my options considerably.,.

  • maracujation

    I just started my first job out of grad school on February first. I had some debt and I have been paying it aggressiveness to get rid of it and start saving for an emergency fund and retirement.  I finally would pay off my last credit card next month and I would have $1500 to pay my dad and I am done owing money (my dad is a bit more flexible but I also want to have it done as soon as possible).  However I am having trouble setting my priorities between paying my dad, starting my emergency fund, retirement, and saving for a wedding.  Right after credit cards are done with next month) what should I do? any suggestions? these are my thoughts for now …
    1) wait for my end of the year review and start putting money in my 401K then
    2) Split whatever I was putting to pay my credit card into emergency fund/ savings for wedding/ paying my dad (may be do it automatically after I have some cushion in my account) – paying my dad is a priority so I am done owing people money
     3) Get a second part time job if possible so I can build my emergency fund faster and have more money to put towards our wedding and a house down payment (and other things like vacation, etc)

    what would you do?

  • APnyc

    I like this article a lot. I feel that LearnVest often purposes (great!) solutions to tricky topics and situations concerning money, however it does not offer advice for those who already have their finances in check. Just because you don’t have debts or are employed full-time doesn’t mean you don’t want further good advice on situations you may already have under control. The second half of the article which offers several different scenarios is great. LearnVest, please keep posting for those of us who have worked hard to get our finances in order and educate about what we can do if we’re fortunate enough to have excess. Thanks. 

  • Lbeemoneytree

    I think part of knowing what is and isn’t an emergency is also a hard lesson between needs and wants, which I am learning right now. Follow my journey! http://www.lbeeandthemoneytree.com

  • Betsy

    Hi!  I’m curious where you recommend keeping your emergency fund?  I know it needs to be quite liquid, but seems a waste to have it sitting making a very minimal savings account interest?  any advice?  Thanks!

  • Sue

    I have been working on doing all of this & have done more in past 6 months than in last 6 years. HOW? I made myself my #1 priority. I was lucky to get a good job that I love & work from home after being unemployed in 3 unexpected layoffs in past 7 years. I helped a friend financially for 6 years & only focused on his financial welfare. Now, in 6 months, I have $4500 in my emergency fund, have paid off $2000 in medical bills & $1000 off my credit cards, am no longer paying late fees or juggling payments. I still have a great deal of debt including credit cards, but I sleep at night, work only 40 hrs/wk & actually believe I will have credit cards paid off in 3 years. Previously I worked min. 50 hrs/wk, did not sleep @ night, had a heart attack & did not know how I was going to make even minimum payments. I have not felt this positive about my financial future since I was 19 & now my goal is to be able to retire in 3-6 years.

  • Ryn0man

    I disagree with “travelling for a family funeral” – it’s no less optional than a wedding. There’s no point in ruining your future to pay respects to someone who will never know you were there. Put some time aside to achieve closure for yourself, ignore the people who judge you for not making it to the funeral, and keep your future intact.

    • Canwebenice

      Ignoring this part of life is debilitating for some. You are a man and whatever else drives you to this conclusion makes it ok for you. I agree if it is someone that was a distant friend or relative than this would be a relevant argument. For some it is not just stiff-upper-lip mentality. Our financial well-being is not the only consideration in life. It is one thing if there is no money to travel then most would come to terms with this harsh reality. On the other hand, it is entirely another matter when there is an emergency fund set up to do such things :)