Alternative approaches to emergency savings
Having money for these rainy events is crucial for Americans and their financial situation.
But most Americans find it difficult to fund an emergency expense. A recent GOBankingRates survey found that 57.4% of Americans saved less than $ 1,000 on emergencies. A separate Bankrate.com survey found that 39% of adults in the United States would not be able to cover an emergency expense of $ 1,000 using their savings, a statistic that has held up since around 2014.
While the past 15 months have led to better savings habits and higher disposable income than before the pandemic among some higher-income adults, those who live paycheck to paycheck don’t are still not saving enough.
For many people, saving for an emergency fund is the first step to financial well-being before saving for retirement. Taking care of this emergency fund is crucial because if you don’t have it and something happens you could get into debt and snowball.
You’ve been told that you should still have around three to six months of living expenses in your savings account in case something happens. But maybe you don’t have enough money to put aside today, or maybe you don’t want six months of cash to stay in an emergency fund.
For these people, there are creative ways to have an emergency fund. The four that I’m going to cover in this article are: Roth IRAs, Health Savings Accounts (HSAs), Using Your Home Equity, and Considering Smart Ways to Use Credit Cards.
The Roth IRA
Roth IRAs are a really interesting emergency fund vehicle because your contributions to a Roth IRA are made after-tax and you can access them at any time without negative tax consequences, both from an income tax perspective. than the tax penalty.
You really have two parts of Roth IRAs: First, you have the tax-free investment growth part (but it is only tax exempt if you meet certain holding period and trigger event requirements) ; Then, if you need to dip into the Roth IRA funds in an emergency, you can dip into the other part – your contributions – without incurring an additional tax penalty.
Some Important Considerations When Using Roth IRAs As Emergency Savings Vehicles: It is not as easy to put money back into a Roth IRA once you have withdrawn it. While you can repay within 60 days as a rollover, you can only do one of these 60-day IRA-to-IRA rollovers per year (every 12 months) on all of your IRAs.
When making a withdrawal, try to withdraw only your contributions – not your income – to avoid penalties. Growth of investments in a Roth IRA could be subject to both income tax and a 10% early withdrawal penalty if it is distributed within five years of the account and you are under 59. and half. In other words, limit the amount you withdraw to cover your emergency to the amount you put in your Roth IRA.
You should also consider your underlying investments in your Roth IRA. If you can make sure that part of your Roth IRA isn’t invested in anything volatile, it can work as a better emergency fund. For example, if you are investing heavily in growth stocks and you have to sell stocks during a volatile time when you also have an emergency, it could have a negative impact on you, or you might not have enough money to spare. meet your emergency needs if stocks pull out. too far back. Instead, you might want some of your investments in bond funds or some other less risky asset if your Roth is also serving as an emergency fund.
For many people, emergencies can often take the form of unexpected medical events. In such cases, you could dip into a Health Savings Account (HSA). Your HSA can serve as a good emergency savings vehicle because the money in it can be invested for the long term, but still accessible if you have eligible health expenses.
First of all, I want to note that many people use HSAs incorrectly – or not in the most efficient way. They use them as Flexible Spending Accounts (FSA), pumping money in and withdrawing it all in the same year to pay their deductible into a high-deductible health plan. In this situation, the HSA provides a tax deduction for the amount you put in, up to the annual limit ($ 7,200 for a family in 2021). However, you forgo the tax-deferred growth because you can invest that money, and the tax-free investment gains you receive if they are spent on qualifying medical expenses in the future.
But if you contribute to an HSA, the biggest benefit is actually obtained by investing inside the HSA and letting your investments grow tax free – not the tax deduction in the first year. Think of your HSA as a health care retirement savings vehicle, not just a way to deduct your deductible for the year.
In reality, HSAs are great vehicles for long-term savings due to the triple taxation: you get an initial deduction, tax-deferred growth, and you can use the money for your health expenses. unforeseen and qualified tax-free.
Use these vehicles more strategically and efficiently as part of your savings plan, both for future health care costs expected in retirement and as a buffer for emergency health care costs.
The equity in your home
Some people might not be comfortable with this one, but tapping into your home equity using a line of credit or other lending strategy can play an important role in your emergency savings plan. .
One strategy is to set up a home equity line of credit (HELOC). Some HELOCs can be set up with little or no upfront costs. Instead, the costs come into play when you actually borrow from HELOC and tap into the line of credit. This strategy gives people the ability to borrow if or when an emergency arises, without negatively impacting their investments or cash flow if they don’t need the money. However, keep in mind that once you borrow from HELOC, you will have to repay the loan and earn interest on the debt – which could snowball if left unmanaged.
A lot of people use lines of credit to renovate their home, such as when a tree falls and damages the house and maybe insurance will cover it, but you still need to find the extra cash. Or you have a $ 500 home insurance deductible that you need to cover.
Think of your home as an asset and how to use it to become a potential vehicle for emergency funds, if needed. But before you start borrowing for your emergency fund, make sure you can pay it off and that you understand the costs of borrowing.
Your credit cards
Another borrowing strategy can ease the amount of money you hold on to in an emergency. Personally I think my emergency fund includes credit cards so I’m probably keeping less money in the short term because I know if I have an emergency using my credit cards is an option. . However, this strategy works best if you have a steady income each month so that you can keep track of your credit card payments.
Obviously, the risk with this option is high: if you have an emergency and for some reason cannot work, it might be difficult to pay off the credit card, which could get out of hand. Interest rates on credit cards are often some of the highest you can incur. In general, it’s best not to carry credit card debt month-to-month, but debt can get you through a rough time or emergency if used wisely.
It is more reasonable for people to have three months rather than six months of spending in cash. However, the downside to saving so much money is that it is not invested and will not work for you in the long run. While it’s a good idea to have a certain amount of money set aside for a rainy day, you need to determine what the right amount of savings is for you.
You also need to figure out how to stack the other savings vehicles mentioned in this article in case something unfortunate happens – you lose your job or have an accident or have health expenses, and you need to find a large amount of savings. money. But some of them – like HELOCs and using credit cards – reiterate the importance of having good credit on your behalf and managing your debts.
If you’re having trouble getting out of this on your own, contact a financial planner who can help you determine the best approach for you.