Emergency Funds: What They Are and Why You Need One

Imagine you get into a car accident or notice a leak in your roof. Perhaps your company is acquired and the new owner shuts down your division, leading to job loss. Do you reach for a credit card and go into debt to cover expenses, or will you have money you can tap into while you get things back in order?

More than two-thirds of Americans say they would be somewhat or very worried about covering a month's worth of costs after a job loss, according to a recent survey by Bankrate.¹ Working toward building this safety net takes time and dedication, but knowing you're prepared to cover an unexpected expense can relieve a lot of stress and anxiety.

What Is an Emergency Fund and Why Do You Need One?

An emergency fund is cash you've saved in preparation for unexpected financial hurdles such as job loss, large medical expenses or any other financial curveballs life throws your way. With an emergency fund at the ready, you won't have to borrow money to pay for any unbudgeted costs that arise.

Along with providing ready assets for a short-term need, an emergency fund also helps preserve your long-term plans. Should you face an unexpected expense, you won't have to tap into your retirement savings—meaning you'll avoid paying penalties for early withdrawals. That way, your retirement savings can remain hard at work for your future.

How Big Should Your Emergency Fund Be?

The standard wisdom is that your emergency fund should cover three to six months' worth of expenses. Imagine you lose your job: How much money would you need to keep things going while you find a new one?

Don't worry if that amount seems hard to reach. Even a small emergency fund is better than none, and once you've reached your first savings goal, you can reassess and aim for a higher number.

Those in multi-income households may be able to get by with less because their household income is diversified, while those in single-income households may feel safer with a larger savings fund. If you have children or other dependents who rely on you financially, you'll want to make sure you factor those costs into your emergency savings plan as well.

Your life situation will affect your needs, too. If you rent, for instance, you don't have to worry about leaking roofs and failing furnaces.

In addition to the everyday expenses you might have to cover with your emergency fund if you end up out of work, potential unexpected costs to consider include:

• Car-related costs, like replacing tires, fixing broken parts or paying the deductible if you need repairs after an accident.
• House-related costs, like fixing a roof, furnace or air-conditioning, or replacing a broken appliance.
• Medical emergencies, like major dental work, an emergency room visit or taking time off work to recover from illness or surgery.

How much these things cost depends on a number of factors, including where you live and what kind of insurance coverage you have.

How an Emergency Fund Helped One Couple Survive a Layoff

Julie and Dennis Lawson always knew they needed an emergency fund, but building one has taken time and commitment. Early on, the couple from Wichita, Kansas, struggled to prioritize their savings—they had two young children and their careers were just getting underway. But as their children grew, so did their paychecks, allowing them to finally reach their goal in their 40s.

“The greatest benefit I've received from having an emergency fund is knowing that if something happens, we'll be OK," says Julie, now 55.

Over time, the Lawsons built their emergency fund with automatic deductions from their paychecks and a commitment to not touch their savings except for true financial emergencies. And when an emergency arose, they were prepared.

After a layoff, Dennis was out of work for more than a year, but the couple's emergency savings kept them afloat. When he found work again, it took several months to get back on track with saving, Julie says, but they were eventually able to replenish the funds.

Julie says the peace of mind that financial preparedness brings is well worth it. “It's such a relief to know that if the AC goes out, we have the funds to fix it," she says.

READ MORE: 10 Steps to Financially Prepare for a Layoff

Where Should You Keep an Emergency Fund?

Your emergency fund should be relatively liquid, meaning you can access it easily and quickly without having to sell or cash out other investments. At the same time, you don't want it to be so accessible that you're constantly dipping into it to cover everyday expenses.

To maximize your savings, consider keeping your emergency fund in an account that earns more interest than a regular savings account. The following types of accounts from Synchrony Bank may be a good fit for your emergency fund:

• High yield savings account. This FDIC-insured account offers a higher interest rate than a regular savings account, giving you a better return on your money.
• Money market account. This FDIC-insured account combines the best features of a savings and checking account into one. You can make deposits, write checks and withdraw funds easily, but you also get a competitive interest rate. (Note that money market accounts are not the same as money market funds. The latter is an investment that could lose value if the market fails, while a money market account is insured by the FDIC and the National Credit Union Administration for up to $250,000 per account holder, per insured bank, for each ownership category.)

Keeping your fund separate from your regular savings or checking account can help ensure you don't spend it on anything other than real financial emergencies.

READ MORE: How Bucketing Can Help You Save More

How to Build an Emergency Fund

Building an emergency fund from scratch might seem daunting, but taking small steps toward saving can add up.

To get started on a savings plan, determine how much you want to set aside. Your exact goal will depend on your specific circumstances, but a good starting point is to save at least three to six months' worth of living expenses.

To help determine how much emergency savings you may need, you can use an online calculator. For example, try this one from the American Institute of Certified Public Accountants.

Once you've settled on a savings goal, it's time to get started. Use Synchrony Bank's savings calculator to figure out how much you should set aside each month and how long it will take to reach your target. While working to build your emergency savings account, it's important to continue making at least the minimum payment on your credit cards and, if possible, continue saving for retirement.

Here are some ways to kick-start an emergency fund:

• Set it and forget it. Commit to saving a certain amount, then set aside a portion of your paycheck to go directly toward your emergency fund via an automatic deposit.
• Cut back. Look for opportunities to trim expenses so you can put that money toward your emergency fund savings goal. For instance, you might decide to pack lunch a few days a week rather than always eating out.
• Sock away unexpected windfalls. Dedicate a portion of bonuses or raises to go toward your savings. If you get a tax refund, direct that cash toward your emergency fund.
• Get ahead of tax season. If you expect to get a tax refund (e.g., due to deductions or tax credits), consider adjusting your tax withholding now and putting the extra money you receive into your emergency fund.²
• Sell your stuff. Consider selling any household items, clothes or hobby supplies you don't use and putting the money you earn into your emergency fund.

The Last Word

By setting a savings goal and regularly contributing to your emergency fund, you'll gain the confidence that you can handle financial emergencies—without jeopardizing your long-term plans.

READ MORE: Three Strategies to Create Realistic Savings Goals