What does the massive Winter Storm Nemo have to do with the need to have an emergency fund? In short, everything. Nemo is symbolic of any un-foreseen event that may disrupt one's income or cause a financial hardship. From a simple power outage to a long-term illness, being prepared to handle an emergency can mean the difference between peace of mind and having your family's world turned upside down.
What is an Emergency Fund?
An emergency fund is an account that contains easily accessible liquid funds that can be used to cover expenses in the event of illness, job loss, or unexpected major expense. According to the US Beauru of Labor Statistics the average U.S. household in 2010 had expenditures of $48,109 which would require a 6 month emergency fund of $24,054 or a 3 month emergency fund of $12,027.
How Much Should I Have in My Emergency Fund?
That depends on your lifestyle and your source of income. Do you work for someone else or are you self-employed? If you are self-employed and your business is interrupted, your income will also dry up unless you have business interruption insurance. If you become injured or disabled you will be unable to work and will need a disability insurance policy to replace lost income. According to a 2004 study by National Underwriter, at age 40 your chances of becoming disabled for 90 days or more before age 65 is 43%. If you lost your job or had an interruption in income, how would you pay your mortgage, car payment, or a child's education expenses? Disability insurance only partially covers lost income and additional funds in an emergency fund would be required to make up the difference.
In a disaster your income may be just one of the issues you may have to deal with. Storm damage may or may not be covered fully by your hazard insurance policy. Flood and hurricane damage is an example of natural disasters that are not covered by most insurance policies. Many New Englanders are still homeless and battling government red tape after Sandy and many homeowners will never fully recover financially. With flood waters comes mold, another potential problem that can wreck your savings since insurance policies generally do not cover removal and remediation.
A fire can be particularly devastating not just from the loss of your home but the loss of irreplaceable possessions. Making sure you have a full replacement cost policy with endorsements to cover recreational vehicles, jewelry, computers & electronics, or business inventory will speed the process of rebuilding your home and replacing the contents.
Sources of Funds in an Emergency
Short-term disability Insurance– most short-term disability policies replace between 66%-70% of your weekly income and since taxes were paid on the premium no taxes will be due on the benefit. Benefits last between 22-26 weeks or until long-term disability insurance begins.
Long-term disability Insurance– most long-term disability policies replace on average 60% of your income. You can purchase supplemental long-term insurance that will cover the difference in lost income. If you are under age 55 you can expect to pay 1%-3% of your annual salary in premiums or 4% of your annual salary if you are over age 55.
Social Security Disability Insurance – Most SSDI recipients will receive between $300 and $2,200 with the average payment in 2013 being $1,132. The maximum benefit in 2013 is $2,533.
IRA/401k Investment Funds – In the event of a serious injury or illness, the IRS will waive the early withdrawal penalty for IRA funds used to pay for non-reimbursed medical expenses. The catch? Medical expenses must be in excess of 7.5% of your AGI and funds must meet the 5-year waiting period.
Roth IRA – You can access your contributions at any time without penalty for emergencies. If you are unable to fund both an emergency fund and a Roth IRA, consider funding a Roth IRA first as you are much more likely to have a better return with the Roth account than a typical bank savings account. Plan on having sufficient cash available to cover expenses until funds can be disbursed from your Roth IRA account.
As you can see, insurance protection is an important part of being prepared for an emergency and also allows one to drastically reduce the amount of funds required for an emergency fund.
Readers: Do you have the right combination of insurance and cash to protect you and your family in the event of an emergency?