5 Ways an Emergency Fund Keeps You out of Debt
By now, you may already know you need an emergency fund. But working towards saving one up hard part.
Am I right?
Building the popular, 3-6 month fund that most experts recommend is a long game, especially if funds are tight and you’ve been trying to pay down debt.
But the emergency fund is a crucial component to your financial freedom.
It’s one of the tools you’ll need to become financially independent; combine it with paying off debt, your household budget, frugal living, and savings; your emergency fund will keep you out of debt when life throws you those inevitable curve balls we don’t like to think about.
And life WILL throw you curveballs and shit all over your party. Something will happen that threatens your financial wellbeing.
You’ve heard the saying, “Nothing in life is guaranteed except for death and taxes.”
Well, let’s add job-loss and home repairs to that because it’s just how things go.
When life catches you by surprise, you don’t want to go into more debt. You want to be insured against life’s unexpected possibilities.
So how can an emergency fund help protect you financially? We’re going to dive into five ways it can keep you out of debt.
1. Financial security in case of job loss
An emergency fund can replace your living expenses if you lose your job.
According to the US Bureau of Labor Statistics, the average length of time spent unemployed was 20 weeks (Dec 2019).
Use that statistic to plan how much you should save in your emergency fund. You want to be able to pay the bills while you’re looking for another job and not have to rely on dipping into your retirement fund or live off of credit cards and personal loans.
I have friends who have done both while unemployed (one dipped into retirement and one lived off credit cards) and both have had to pay the consequences years later.
One friend ended up with credit card debt over $10,000, and the other ended up having to pay a hefty tax bill.
I’ve been unemployed myself but luckily I had a small emergency fund (and lowered living expenses) to live on.
The stress was real because I could not find a job right away, but I'm thankful that I didn’t need to dig into credit cards or tap my retirement fund before finding my next job.
The last thing you want to do is go into debt while trying to find another job. It will only add to your desperation and stress level.
2. Unexpected medical bills
According to a CNBC report, 137 million Americans are struggling with medical debt, and it’s the #1 reason people tap into their retirement accounts or file for bankruptcy.
One day you or your child may have a medical emergency and you may need to cover the deductible before full coverage kicks in.
What’s scary is that depending on your health insurance, some deductibles can be in the tens of thousands of dollars.
If you have pets, your pet could have a medical or dental emergency you didn’t plan for, especially if it’s young. My pup always got sick, or got hurt when he was young.
The best plan is always prevention but when it comes to kids and pets, I heard it’s frowned upon to wrap them up in a bubble.
The next best thing would be having a good health or pet insurance plan and some money put aside to cover what insurance won’t cover.
3. Family emergencies
If you live a plane ride away from family, you’ll need money to take care of travel and incidentals in the event you need to leave home in a hurry.
Someone will get sick and someone will pass away. It’s a sad but realistic part of life. But as tragic as this is, the tragedy doesn’t have to extend to your finances.
Your emergency fund can cover travel expenses, living expenses if your job doesn’t offer enough time for leave, or help with funeral expenses.
4. Unplanned car & home repairs
Aside from the regular maintenance you can plan for, an emergency fund is there for any unexpected costs that occur to your home and vehicle.
Use the funds to cover things that insurance or warranties won’t cover, like deductibles or certain types of damage if you’re under insured.
That’s what happened to me when my house had a foundation leak. My insurance didn’t cover it and the home warranty I had only covered $1500 of the work.
The entire plumbing reroute would cost around $4000. I didn’t have the money saved so I had to take out a personal loan; it had to be quick too because water was running somewhere into the foundation.
It took me two years to pay that money back. I don’t want you to be in that situation.
If you own a home, rent a home, or own a car, you will have an unexpected home or car repair that comes up. Your emergency fund can be there to keep you out of debt.
5. Tax liabilities
With all the changes to the tax code in recent years, it’s more likely you could face an unexpected tax bill.
For example, if you’re a solo business owner/freelancer who forgot to pay quarterly taxes, you may incur tax penalties. Or you may have forgotten to include a couple of 1099’s because you moved some investments around.
Or maybe you messed with your W4 (like I did one year) and ended up with a huge bill because not enough taxes were taken out of my check throughout the year.
I’m not a tax professional by any means but I do know that having money saved on the side can relieve tons of stress if you find yourself faced with an unexpected tax bill.
What is the true purpose of an emergency fund?
An emergency fund is an insurance policy to cover life’s unexpected events. Since death and taxes are a sure thing, and health and jobs are not guaranteed, we should be saving for these things.
The purpose of your emergency fund:
- Replace your income in the event of job loss or unexpected travel
- Help maintain your lifestyle and pay bills during illness and/or job loss
- Provide funds so you can stay out of debt during an unexpected financial emergency
- Reduce your dependence on an employer or family members to provide financial support
- Increase financial opportunities
- Allow you to take advantage of compound interest (when not in use)
What is considered an emergency?
While everyone’s financial situation is different, when it comes to using your emergency fund, it would usually fall into one of the above five unexpected scenarios. However, you could have a financial life event that falls outside of one of the five scenarios I cover in this post.
Your fund is best used with a household budget. If you have one in place, all other expenses should be taken care of.
So your emergency fund will likely be used on something you didn’t budget for; it would fall under something financially challenging and “unexpected.”
With the precarious state of debt in America, and the instability of the job market, we shouldn’t be financially reliant on employers and commercial insurance to support us when financial emergencies occur.
We’re more likely to experience a job loss, tax issues, or health issues - all things that jeopardize any financial gain we might have accomplished by working on savings, retirement, and a household budget.
The best time to save money is when you don’t need the money, that's while you’re working.
Get on a household budget, reduce expenses, pay off debt, and save money like your life depends on it.
One day, you’re going to need extra money in a pinch, if you have an emergency fund, it will be there for you so you don't have to into debt.