What's an Emergency Fund and How Much Do I Need?

An emergency fund is a cash reserve of money set aside, separate from a primary checking account and savings, to be used for unexpected emergencies that often require upfront payment. Not having money on hand to pay for certain living expenses may leave you in a bind or cost exponentially more than the emergency alone. Shockingly, according to a recent U.S. News survey, two out of every five Americans — and nearly half of all women — have no emergency fund whatsoever. ^[1]

For those with an emergency fund, some wisely choose to invest their cash reserve in low-risk options so their safety net grows over time. Here’s everything you need to know about why you need an emergency fund for financial well being, which type of separate account is best and how much you should ideally save for unexpected events.

Key Takeaways Park your money in an institution that is FDIC insured or insured by SIPC. You have a few options of where to keep an emergency fund. Save automatically, whether it’s a split direct deposit or automatic transfers. Compare all your insurance product rates to trim down your existing bills.

What Is an Emergency Fund?

An unexpected expense, like having to replace an iPhone, paying for a new transmission or visiting the emergency room, may be a financial strain if you’re not prepared with an emergency fund.

An emergency fund should be separate from all other accounts, ideally even your savings. The trick is to only use the funds for financial emergencies without dipping into it for other reasons.

Your regular bills are not included in an emergency fund. Payments made monthly, semi-annually and annually should be included in your budget.

For example, a health insurance deductible for someone with a PPO plan is expected, because you’re paying for medical bills out of pocket until you reach the deductible and that cost should be included in your budget based on the number of projected visits a year. However, if you unexpectedly visit the emergency room, you may have a large expense that may come out of the emergency fund.

Withdrawing money from a 401K plan will leave you vulnerable after you retire.

Why Creating an Emergency Fund Is Crucial

There are many reasons to have an emergency savings fund. If you have to take on a large and unexpected expense without a surplus of cash on hand, you’ll pay interest fees on credit cards and loans.

Withdrawing money from a 401K plan will leave you vulnerable after you retire, plus you will be charged an early withdrawal fee, thereby diminishing your retirement plan. Below, you’ll see common reasons for creating and using emergency funds.

16 Common Reasons To Dip into Emergency Funds

Unexpected expenses are reasons to withdraw money from emergency funds, instead of relying on high interest loans. See all the common reasons people should start saving an emergency fund below:

1. Home Repairs

2. Home Insurance Deductible

3. Home Maintenance (lawn care, filter changes, etc.)

4. Home Appliances Repairs or Warranty Deductibles

5. Car Repairs

6. Car insurance Deductible

7. Medical Bills

8. Job Loss

9. Veterinary Bills

10. Pet Boarding

11. Funeral

12. Special Occasions and Gift-giving Holidays

13. Lost or Damaged Cell Phone

14. Computer Repairs or Replacement

15. Miscellaneous Unplanned Expenses

How Much Should an Emergency Fund Be?

While you may dip into it for other reasons, generally speaking, an emergency fund should enable you to pay all your expenses before you get back on your feet, if you lose a job or any type of regular income.

A good rule of thumb is to have three to six months of expenses at your fingertips. ^[2] The range is wide because different people have different incomes, savings, monthly expenses and lifestyles. Someone with children will want to have closer to six months worth of lost income.

How To Build an Emergency Fund

Putting aside money may seem impossible, especially if you’re living paycheck to paycheck. However, even if you’re saving $25 to $50 each pay period, you will eventually reach your desired savings goal. If you can save even more with each paycheck–even better!

First, determine how much you need for monthly expenses each month. Next, calculate what that would total for at least three months, preferably longer and closer to six months. Having more than you need is better than not having enough if you lose your job, are injured or fall ill.

After you use some of the emergency funds, be sure to replenish the account for future emergency situations.

Using a budget and spending tracker, like YNAB, is a great way to get started. Enter your insurance bills and other regular expenses to see how much you can set aside towards your savings.

Where To Put an Emergency Fund

Where should you put your emergency fund? Checking and savings, money market accounts and cash management accounts are the safest banking account options. Here's more:

Important Factors in an Emergency Fund

An emergency fund should be easily accessible without costing you anything. In fact, it can earn you interest. When choosing a place to keep an emergency fund, remember three words:

1. Liquidity: Can you withdraw easily and without penalty?

2. Security: Is the institution FDIC or SIPC insured?

3. Separation: Is the account separate from accounts you regularly tap into?

Let’s look at some of the most common options below:

Savings Account

A savings account will earn 0.01% to 0.08% interest annually, and that’s yet another reason not to grow your emergency savings in a checking account. ^[4]

If you already have a savings account, you can also use it for an emergency fund, but only if you never withdraw from this bank account.

Some people open a second savings account for an emergency fund. Some savings accounts have higher interest-earning potential too. See more on this below.

High-yield Savings Account

A high-yield savings account can earn 3.6 to 5.0% interest annually. ^[5] The more interest you gain, the faster your emergency savings will grow. The more money you put into this type of savings account, the faster it will grow too.

There may be a minimum deposit amount to open an account, but you can earn 12 times the national average for savings accounts if you scrape up the required amount.

How much you put into the emergency fund depends on how much you can transfer to this account after paying your other bills.

You will still have the same flexibility in withdrawing funds as you do a regular checking or savings account. Also, you can also schedule direct deposit into these types of savings accounts.

Money Market Account vs Money Market Fund

Both money market accounts and money market funds offer low-risk savings investments for higher returns than a traditional savings account. Access to these funds is easy and withdrawals are not penalized.

Money market accounts are typically offered by banks and credit unions. Money market funds are purchased through a brokerage. ^[6] They may or may gain more interest than a high-yield savings account.

Checking Account

If you want to make your emergency savings even more accessible, you can open a separate checking account that you do not use to pay regular bills or make purchases.

Keep in mind that you will not gain interest with a checking account. You can schedule direct deposits into this type of account, if your employer will split a direct deposit, or schedule a regular transfer from your primary checking account.

Cash Management Account (CMA)

Cash management accounts are not offered by banks. You can open a CMA with financial institutions, like investment advisory firms or broker-dealer, and manage the account online. You can withdraw cash as if it were a bank account and some CMAs also offer checks. Funds are insured by SIPC until they are sent to affiliate banks, and are then FDIC insured.

Building an Emergency Fund vs Paying Off Debt

The right answer to which is more important, building an emergency fund or paying off debt is simple: both are important and both can and should be done at the same time. It may feel more urgent to pay off credit card debt without saving, but the truth is that the emergency fund may help prevent more high-interest debt, so it’s just as important. ^[3]

Having a split direct deposit through an employer will allow you to put some of your money directly into your savings account and some of it into checking. If your HR department doesn’t offer this option, you can work with your banker or banking app to set up automatic transfers from one account into another, each pay period, after your direct deposit is received.

Save some of your paycheck for an emergency savings fund and use as much of your paycheck as you can to pay down debt, especially the highest interest debt.

If you can pour your tax refund into your fund to quickly reach your financial goals.

How To Apply for Emergency Relief Funds

The only emergency relief fund that is set up to help people is FEMA and they offer assistance to victims of natural disasters, like floods and wildfires.

You may be eligible for grants to help rebuild your home and disaster unemployment assistance.

FEMA does not replace the need for homeowners insurance and payouts on losses is usually not anywhere enough to rebuild a home.

To apply for FEMA disaster assistance:

• Fill out a DisasterAssistance.gov application online or

• Apply by using the FEMA app

• Apply by phone at 1-800-621-3362.

• Apply in person at a Disaster Recovery Center (DRC). ^[7]

When To Withdraw From Emergency Funds

The main idea in keeping emergency funds is to have a surplus in case you unexpectedly need it. Only withdraw from the emergency funds if you have an expense you didn’t expect to have that must be paid.

For instance, if your cell phone needs a new screen, you’ll probably need to withdraw from emergency funds. Begin replenishing the account right after the withdrawal to fill up your emergency fund again.

Avoid using the emergency fund for unnecessary purchases.

Can Insurance Help With Emergency Funds?

You will need emergency funds in case you file a car insurance claim after an accident, because you’ll be left with the deductible amount to pay on your own. Sometimes, you will need even more. The same goes with a sudden illness or injury. After which the normal number of doctor visits per year may quadruple–or more. You’ll be left digging into emergency funds also if you file a home insurance claim, because your deductible will be subtracted from the payout, leaving you with insufficient funds to pay for repairs or replacement of property..

What you can do is compare insurance rates each year to ensure that you are paying the lowest insurance rates possible, whether it’s health insurance, car insurance, home insurance, renters insurance or business insurance. Saving $50 to $300+ a month in insurance bills means you have $50 to $300 a month to put away and keep your emergency fund full.