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Your Emergency Fund: The 411

Apr 20, 2017 3 min read Rachel Moehl

 

If you want to know why you need to have (and possibly use) an emergency fund, you need just go as far as defining “emergency.” To paraphrase online definitions -- it’s a dilemma, a hard time, a bump in the road. It’s anything that disrupts the flow of money coming into your household (your income) or requires a “fix” that exceeds the money you have on hand.

Experts often say that reserving four to six months’ expenses in a savings account as an emergency fund will help you combat unforeseen disasters. But why?

 

The timeline of an emergency

"Emergency" could be applied to many situations: job loss, prolonged periods of illness, hurricane, flood, fire, tornado, etc. You stop receiving a paycheck. You can’t get out of bed to take care of life’s odds and ends: cooking, cleaning, driving the kids to soccer. Your roof has a hole in it, or your basement becomes a giant lake.

Even a lesser emergency like a furnace or water heater breakdown can mean having to pay out money unexpectedly. Is your refrigerator kaput? That’ll be $200 to $2,000 (or more) to replace. If you are living paycheck to paycheck, you might not have cash on hand to buy household appliances that break. An emergency fund kicks in when you don’t have enough coming in to cover what is going out.

However, emergency is a temporary state. Emergencies are sudden and urgent. When they last longer than six months, they graduate to circumstance. That’s when you might want to rely on other financial conventions for relief: disability insurance, homeowner’s insurance, downsizing your expenses or increasing your debt. An emergency should not eclipse your entire life, forever.

 

Lost your job and looking for a new one?

The United States Department of Labor, Bureau of Labor Statistics reports rates of job loss due to discharge or layoff Opens in new window at roughly 1.5 million to 2 million jobs per month, across the whole of the U.S. in 2016. Even though new jobs are being created all the time (at an average of roughly 5 million jobs per month Opens in new window in 2016), it can take four to six weeks – or even longer – to fill a new job opening. That means that you could spend that amount of time on each job for which you are a serious contender.

Job hiring times vary widely by industry and region. Generally speaking, one can collect unemployment benefits for up to 26 weeks (or six months), but that number varies by state. In essence, unemployment is a de facto emergency fund. The standard payout period was developed to cover unemployed people for long enough to acquire a new job. Keep in mind that unemployment benefits will only cover up to 60% of your earnings Opens in new window, as assessed from your base period (the first four of the last five calendar quarters that directly proceeded the date of your claim).

If you find yourself out of work for longer than six months, you might need to consider alternative employment options by changing jobs or going back to school. You might draw upon your emergency fund to pad unemployment benefits or help pay for vocational training.

 

Waiting for homeowner’s insurance to kick in?

The Data Center reports Opens in new window that, in 2005, Hurricane Katrina damaged more than one million homes in the Gulf Coast region. Of the $120.5 billion in federal spending, more than half went to emergency relief rather than rebuilding. Basically, that means that simply getting by, day to day, after a crisis, costs a lot.

While extreme weather emergencies might be rare in your parts, it doesn’t hurt to heed a warning from this and other large-scale disasters. Many states require that insurance providers abide by fair claim practice laws which prohibit unnecessary delays in payouts.

But what do you do if your homeowner’s insurance claim is delayed after an emergency has compromised your house – or if you didn’t carry insurance to begin with (homeowner’s insurance is not required by law, though most lenders will require proof of policy before you can finance a home purchase)? An emergency fund can help you afford temporary housing and even home repairs while you wait and plan for the days ahead.

 

Injured or ill and figuring out your next move?

If, due to injury or illness, you find yourself unable to work, you might turn to your disability insurance policy (if applicable) or to Social Security disability benefits Opens in new window (if approved). Between the time you leave your job unexpectedly and the time your claim or benefits get paid, you might need an emergency fund to cover your expenses and any other emergencies you encounter.

Disability benefits, however, are not predicated on your former income or the severity of your disability. In 2016, the most a Social Security disability benefit payout Opens in new window could amount to was only $2,639 per month; and many payouts were much lower than that. You could borrow from your emergency fund to cover your temporary urgent needs. (Perhaps it’s also smart to pick up disability insurance during open enrollment while employed.)

 

Bottom Line

Unemployment benefits, insurance claims and other relief measures for the emergencies we endure have been designed to assist us within six months of our job loss, disaster or disability crises. Hence, many financial experts suggest that we reserve six months’ expenses in an easily accessible fund. If you live with above average risks – or these measures seem insufficient or unreliable to you, you might want to exceed that savings rate to make sure you are amply covered.

 

Rachel Moehl is a mother, wife and writer – in that order. She is the Digital Content Strategy Director at Prudential Financial. She also needs to get financially prepped for the zombie apocalypse.

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