You pay your bills on time, you’re investing in a retirement account, and maybe even started a college savings fund for your children. You’re financially responsible. But how would you be able to handle a financial emergency? Perhaps you’re one of the 23% of Americans who have no savings to deal with financial emergencies, or the 22% with less than three months of savings. That doesn’t have to be the case! You can easily create a financial emergency plan, which will put you in a comfortable place should unforeseen, large expenses quickly arise.
Examples of Financial Emergencies
A financial emergency is an unexpected expense that has the potential to negatively impact your finances. It can drastically decrease your income, require a hefty one-time payment, or bring substantial, on-going payments for months or years. A few examples include:
- Major home repair
- A totaled car
- Medical emergency for you or a dependent
- Natural disaster
- Losing your job
- Death of a spouse
Preparing for Financial Emergencies
Pay Down Debt or Save?
A major hurdle that many people run into when it comes to creating a financial emergency plan is the amount of outstanding debt they are carrying. Balancing debt and savings can be difficult, because they are both priorities.
Paying down high-interest debt seems like it should be the first thing on your to-do list, but financial experts actually recommend that you should address an emergency savings first. A financial emergency can hit at any time and if you’re not prepared, paying for an emergency can cause your debt to skyrocket even further.
Your best approach might be to address both of these needs at the same time, dedicating even a small amount of money to both savings and debt repayment each month. Take the time to honestly evaluate your monthly income and expenses. Reference your pay stubs and bills for exact numbers — don’t just guess. If you have, for example, $200 remaining at the end of the month, consider putting $100 into savings and $100 towards paying down debt.
Build an Emergency Savings
Putting away whatever extra money you have each month into an emergency savings account is the best way you can be prepared when a financial emergency hits. Having a reserve of money that you can immediately access to pay a large bill or use to pay your regular expenses can do wonders to relieving the immediate stress that comes during an emergency.
There is no one-size-fits-all amount for a financial emergency plan. It’s typically recommended that you build an emergency savings that can cover three to six months of expenses, so this amount will be different for every individual. Chelsea Fry, Director of Retail Delivery Services adds, “While building an emergency savings is an important part of a solid financial plan, it is also important to realize it doesn’t happen overnight! The most important piece is that you have a plan and that you are working toward achieving your goal of security.”
Choosing the right account for your savings is important because you’ll need to access the funds quickly without penalty when the time comes. An emergency savings is not meant for growth, so your IRA or investment account is not the right place for your money. Instead, choose a standard savings account. Although you won’t earn much interest on your money, you can access it at any time.
When Financial Emergencies Hit
Access Other Money
Typically, you would be penalized if you withdrew money from a 401(k) or IRA before you reach retirement age. However, in a financial emergency, there are ways you can access the money in these accounts for short-term needs. Check to see if any of your accounts have a loan provision. This allows you to borrow funds without paying taxes or penalties on the amount, as long as you are repaying the loan. If a loan is not an option, you may also be able to use the option of a hardship withdrawal.
When you’re facing a financial emergency, squeezing any extra money from your monthly expenses can be invaluable. Look at how many of your expenses are fixed expenses (the same payment every month — mortgage, rent, car payment, student loans) versus variable expenses (payments change each month — credit card bills) and start with your variable expenses when you need to make cut-backs.
Of course, groceries, housing, electric, heat, and transportation should be among the expenses you prioritize. From there, look for opportunities to reduce what you’re paying for cable and internet access, your wireless plan, gym memberships, or dining out. Pulling an extra $20-$25 from a few of these expenses can go a long way when covering the costs of an emergency.
Get Help from Your Lenders
When a financial emergency hits, you should also reach out to your mortgage, auto, or student loan lenders. Talk to them about the options available to you so you can continue to make payments and avoid going into default during times of hardship. If you’ve been a customer in good standing to this point, they may be willing to extend the terms of your loan, which can lower your monthly payments, or allow you to pause payments. If you’re in the middle of a medical emergency, you can also reach out the hospital and work with them on a payment plan that will work for your circumstances.
You’ll have the best results for successfully negotiating with your lenders if you reach out early, before your payments become delinquent.