Why you need both retirement savings and emergency savings

First, what’s not an emergency expense: foreseeable expenses, such as loan payments, new tires, hot water heater repairs, and tax bills—basically, anything recurring. These types of expenses are reasonably predictable and should be included in your regular budget.

Notice that these expenses aren’t only nonrecurring, but, in the case of a major car repair or job loss, they may never happen at all. 

Ideally, you’ll never need to tap into your emergency fund. 

But you might. When people don’t have an emergency fund, they may resort to credit cards and borrowing, and sometimes stop saving in their 401(k), which can create short-term troubles and potentially harm long-term financial security.

How to help prepare for financial emergencies

Step 1: set an emergency savings goal. To do this, sum up potential emergency expenses to arrive at a dollar figure. Above, we listed common emergency expenses, but what other surprises might you be able to anticipate? And how much would they cost? In order to quantify your emergency savings goal, think about things such as:

• Checking your insurance policies for deductible amounts

• Asking your car dealer about the cost of larger repairs

• Investigating the replacement cost of major appliances

• Tallying your everyday living expenses

And don’t assume that emergencies can’t occur simultaneously. 

Step 2: calculate your emergency savings gap (the difference between what you’ve set aside for emergencies today and what you might need). Then decide how much you can afford to contribute from each paycheck to fully close your emergency savings goal gap over a given period of time. 

Step 3: make funding automatic. A 401(k) can be a powerful retirement savings plan because saving is automatic and hard to access. Your emergency savings account can work the same way through automatic saving. Consider setting up a separate account with recurring transfers from your primary checking or savings account. By making it distinct from other savings, you help reduce the temptation to withdraw from it.

Emergencies are unpredictable in timing and scale, and, to some extent, unavoidable, but they don’t have to induce long-lasting financial effects.  

Help prevent prematurely using your retirement savings by calculating an emergency savings goal, determining how much you need to meet it, and then establishing an account funded with automatic transfers. Finally, don’t touch it unless it’s absolutely necessary. 

1 “Survey Finds Most Common Reasons Americans Use Emergency Funds,” Google Consumer Survey, GOBankingRates, https://www.gobankingrates.com/saving-money/budgeting/how-americans-use-emergency-fund/, May 2018.