To be accurate, just about everybody needs an emergency fund. Why? With an emergency fund you’ll have cash available for when things go wrong. And if you have been recently widowed, you can expect just about anything to go wrong. An emergency fund ensures you can deal with the unexpected. You’ll feel better prepared knowing it’s there.
Dave Ramsey, a personal money-management expert, popular author and national radio personality, is a big advocate of emergency funds; in fact, it’s his Baby Step #1. He suggests putting $1,000 aside to get your emergency fund started. He then proposes adding to it in Baby Step #3 after you’ve reduced your debt to only your home mortgage.
His recommendation is to put 3-6 months of living expenses into your emergency fund, which is simply a rule of thumb but a nice starting point. If you were a two-income earner family, with stable jobs and income, three months may have been sufficient. Now widowed, you probably need more than that, up to six months, and perhaps up to a year’s worth if you’re also caring for a young child(ren) or dealing with medical conditions.
The reason for this larger amount is to ensure you don’t fall into debt when there is a crisis – water heaters, car repairs and new roofs are expensive! The last thing you want to do is put the cost of a new furnace on your credit card and make minimum monthly payments while racking up nineteen percent – or worse – interest charges. Nor do you want to be forced to invade your IRA for the cash – especially when you are going to incur taxes and possibly a 10% penalty for early withdrawal. An emergency fund provides you ready and penalty-free cash when things go wrong.
It’s also a good idea to keep these funds liquid, meaning available today. The best place is probably your bank savings or money market account, but not if it’s also providing your checking account overdraft protection. Your checking account is not a good place, because it’s too easy to access. You’re in the habit of spending what’s in your checking account, not saving. Using short-term certificates of deposit – like a three-month CD – may be alright for a portion of your emergency funds, but you don’t want to wait until maturity when you need the money today. I advise talking to a professional to determine the best plan for you.
Alas, an emergency fund may not be your only avenue to extra cash when things go wrong. Did you know that your original investment – and any additional contributions – in your Roth IRA is always available to you? This is referred to as “basis,” and you can access your basis penalty-free if needed. The purpose of a Roth IRA is to grow your retirement savings, so I only recommend this as a “last resort,” but you should at least be aware of this source of cash.
Do you own your home? The equity in your home is also a potential source of extra cash when things go wrong. Consider opening an equity line-of-credit for this purpose. You pay no interest unless you actually access these funds, and the interest you will pay is so much lower than what you will pay if you use your credit card(s). And just in case it bears repeating, credit cards are not emergency funds! They are high-interest liabilities, which is why you need to establish an emergency fund in the first place - so you don't have to rely on credit cards. Check with your lender and see what you might qualify for.
Establishing a well-funded emergency fund provides peace of mind. Set it and forget it. Move on to the other important things on your to-do list. Losing your spouse is also about dealing with the unexpected. Ensuring you have an emergency fund is the financially sound way of preparing to deal with the uncertainties ahead of you.