Kick-Start Your Emergency Fund with Your Tax Return

One morning, the sound of raindrops wakes you up and your first thought is “Not another rainy day! And your second one is, “I’m late for work!”

You make a mad dash through the downpour to your car, turn the key, and … the car won’t start. If you don’t have a rainy-day fund, this could really put a damper on your week.

An emergency or “rainy-day” fund is money set aside to cope with an unanticipated crisis. Things like car, roof or pluming repairs qualify. So does losing a job unexpectedly. Any of that will put a major dent in your budget.

But saving an emergency fund could keep you afloat.

How Much Should You Save in an Emergency Fund?

Traditional financial planners recommend saving enough to cover at least six months of expenses, yet a study by Bankrate found that 66 million Americans have no emergency savings at all.

If you are one of the 66 million, why not use your tax refund to kick-start an emergency fund?

Putting away six months of savings probably seems like a huge mountain to climb, but you will never get anywhere near the peak unless you start, and starting with a tax refund is like turning that mountain into a molehill.

Last year the average refund was $2,860. For a lot of people, especially those just starting their working careers, that’s a really nice start on an emergency fund.

Where to Save an Emergency Fund

When you get your tax refund, the first step is to open a savings account. Check with your bank on their interest rates and then shop around. Ally Bank is good place to start. They have no maintenance fees, no minimum balance and a 1% annual percentage yield.

It’s a good idea to put your emergency fund in a different bank than your checking account. Putting some distance between your savings and checking accounts will limit temptation to dip into the savings too much.

After you open an account, contribute to it on a regular basis. Set up an automatic transfer from your paycheck each week, and think of these charges as just another bill. Something as simple as $25 a week will add up quickly. If you keep adding that tax refund each year, in just five years, your account could grow to well over $23,000.

When to Use Your Emergency Fund

It is important that you use your emergency fund strictly for emergencies. It’s to help you maintain a normal life in what would otherwise be a very difficult situation— and when it rains, it usually pours— so make sure you save it for a rainy day.

  • Loss of a job. Being laid off is bad enough, but being unemployed and in debt, without an emergency fund it could be devastating. The latest numbers from the Bureau of Labor Statistics have the average length of unemployment at 24 weeks, almost six months. That is a long time without a pay check. Even if you get unemployment for some, or all of that time, that still is just 60% of your average weekly earnings. An emergency fund will put food on the table and help take care of  some necessities until you are back on your feet. Then be sure to build the fund back up in case of another unexpected accident.
  • Car repairs. Either a car works or it doesn’t, and they always seem to quit working at the worst time. When your car breaks down, an emergency fund will cover the cost of getting it back on the road, at least until it breaks down again. The average cost for replacing a transmission, for example, varies from $1,800 to $3,500. If you’re in a wreck, auto insurance will take care of the cost of an accident, but you need to have enough cash saved up for the deductible.
  • Home maintenance. There are a lot of moving parts in a car, and there are even more in your house. Anything from an air conditioning repair, electrical, plumbing or roofing can set you back thousands of dollars. Replacing a roof can cost over $ $12,000 for material and labor on an 1,8000-square foot home.
  • Medical Emergencies. In a medical emergency, the important thing is that you return to health. You don’t want to worry looking for a medical debt consolidation service. That is why it is important to have an emergency fund to deal with unexpected medical costs. The median cost of a trip to the emergency room is $1,233 according to a 2013 study by the National Institute of Health.
  • Credit Card debt. Obviously it would be best to avoid this, but in a classic case of overspending, an emergency fund can come in handy. Perhaps there were a few unplanned expenditures last month – theatre tickets, new outfit, dinner, maybe even flowers – and you took care of it with a credit card. Now you’re left with a staggering sum on the statement. An emergency fund will be that safety net that keeps you from going into debt, where higher interest rates could trap you like quick sand.

Situations like that are a fact of life. They happen and there is something you can do about it. Cash that tax refund check and use it to open an emergency savings account.

Be prepared for that rainy day, before it gets here!

Sources:

Bell, C (2016, June 21) Financial Security Index. Retrieved from http://www.bankrate.com/finance/consumer-index/financial-security-charts-0621.aspx

IRS (2016, December 30) Filing Season Statistics. Retrieved from https://www.irs.gov/uac/newsroom/filing-season-statistics-for-the-week-ending-december-30-2016

Bureau of Labor Statistics (2017, February 3) Unemployed Persons by Duration of Unemployment. Retrieved from https://www.bls.gov/news.release/empsit.t12.htm

Home Advisor, How Much Does It Cost To Perform Home Renovations and Repairs? Retrieved from http://www.homeadvisor.com/cost/additions-and-remodels/perform-major-home-repairs/

NA, ND. Roof Replacement Cost 2016-2017: Materials & Labor Costs Updated. Retrieved from https://www.roofingcalc.com/roof-replacement-cost/

Joey Johnston
jjohnston@incharge.org

Joey Johnston has more than 30 years of experience as a journalist with the Tampa Tribune and St. Petersburg Times. He has won a dozen national writing awards and his work has appeared in the New York Times, Washington Post, Sports Illustrated and People Magazine. He started writing for InCharge Debt Solutions in 2016.