Chances are, if you’re reading this blog, you know about emergency funds and savings accounts. But do you know the differences between the two and when to use them? Life’s curve balls don’t always come wrapped in neatly identifiable boxes. So there are times when expenses arise which force us to dip into the piggy bank. But do we dip into the savings or the emergency fund? Both? What’s the difference?
Let’s start out by defining specific uses:
Emergency Fund: Usually consists of unplanned expenses, the ones that pop up with no warning such as unexpected bills, deaths, job loss, illness, unexpected life circumstances and appliance repairs/replacements. I hate to mention it again but since the recession is upon us it is imperative that you have at least 3-6 months saved as any combination of the above is likely to create the perfect storm in your financial life. You’ll be able to sleep easier at night knowing that should any or a combination of the above happen, you’ll be covered in the majority of cases.
Savings Account: This is typically where you save for a specific goal such as down payment on a car or home, childcare expenses, appliances, furniture, educational expenses, investments and hobbies. Obviously, these are planned expenses and not haphazard emergencies. We typically save to meet a certain goal that has been planned for some time. This prevents us from spending money we don’t have through the use of credit cards and increases discipline once the stated goal has been achieved.
The Grey Area This is an area I found myself going back and forth on with my husband because many of these are debatable. We listed the following as being in the grey area: traffic tickets, car getting towed, unexpected tax bill, prolonged medical expenses, legal fees and debt reduction. I’m sure there are more so feel free to list yours in the comments. All of these are debatable which is why they are in the grey area. Still, it makes sense to address these issues before they happen and decide which account should be used to cover these expenses. None of these are planned, but they aren’t dire emergencies either.
Questions to ask your self:
- Which account would you use to pay the junk yard to get your car back?
- What about that unexpected tax bill with April 15th around the corner?
- Legal fees to defend that reckless driving charge?
What about debt reduction? Some believe you should use savings to knock down debt, others believe you can use your emergency fund while some believe in working to pay down debt. I struggle with using my emergency fund to pay down debt because when you know what hits the fan, my bills need to be paid and I would rather pay the minimum in a pinch than give up security. That said I think it wise to create a “when sh*t hits the fan fund” so you’ll be covered and not have to dip into your savings or emergency fund.
What are your grey areas?
This article was originally published on Apr 10, 2008 and updated on March 28, 2012.