Where to put an emergency fund (2024)

In the midst of skyrocketing inflation and an unpredictable post-pandemic economy, Americans are finding it difficult to build savings. According to the Federal Reserve, nearly a third of adults couldn’t cover a $500 emergency expense with their savings. Most would be forced to pay for emergency expenses with a credit card, which only adds interest costs and makes it harder to bounce back from financial hardship.

Life is far from predictable, and having an emergency fund is critical to ensure you’re prepared for unforeseen expenses or a loss of income. Let’s talk about where to put your emergency fund — plus what a healthy balance looks like and tips for reaching that amount.

What is an emergency fund?

An emergency fund is an earmarked portion of savings that you keep on hand for emergency expenses. Emergency funds should generally cover about three to six months’ worth of living expenses to fall back on in the event your primary source of income is interrupted or falls short of covering an unplanned expense.

Here are a few reasons you might need to dip into an emergency fund:

• Home repairs
• Car repairs
• Medical bills
• Veterinarian bills
• Family emergencies
• Living expenses in case of job loss

Your emergency fund should never be used for:

• Vacations
• Down payment on a home or car
• Luxury purchases
• Wedding costs
• Tuition

The importance of an emergency fund

Emergency funds are incredibly important to ensure you’re always prepared for unforeseen financial roadblocks. Without a designated emergency fund, you may find yourself forced to use credit cards or drain a long-term investment account, both of which can lead to additional fees and penalties.

Credit cards should never be relied on as an emergency fund due to their sky-high interest. On average, you can expect to pay over 20% in interest annually when paying off a credit card balance.

Optimal size of an emergency fund

Experts generally recommend keeping between three and six months’ worth of living expenses in your emergency fund.

When determining how much to put in your emergency fund, it might be helpful to first calculate your average monthly expenses. Tally up your total financial obligations, and look through bank statements to see what you typically spend on necessities. These might include:

• Groceries
• Rent or mortgage obligations
• Utilities
• Phone and internet bills
• Prescription medications
• Car payments
• Other loan payments, such as student debt
• Home and auto insurance premiums

Once you have a good understanding of how much money you’d need to survive without income for a month, multiply this figure by three and then six to get an ideal range for your emergency fund. If you’re a single, healthy adult with few expenses, you can probably get away with savings on the lower end; families with children, pets, a home and multiple vehicles should consider saving a bit more.

Where to put your emergency fund

High-yield savings account

A high-yield savings account is a popular choice for those looking to earn interest on the money they park in their emergency fund. With some banks offering 5.00% APY (annual percentage yield) or higher, the returns you’ll get with a high-yield savings account can be significant, especially if you plan to keep a larger amount of money in your emergency fund. Savings accounts, particularly high-yield options, typically offer better returns than checking accounts.

However, there are a couple of things to watch out for when putting emergency funds into a high-yield savings account.

If you bank online or don’t have a checking account at the same institution, you may face a delay of several days to transfer or withdraw funds. Some savings accounts have a cap on the number of withdrawals you can make per month without incurring fees, and many charge fees if the account falls below a certain balance. Keep these limitations in mind if and when you need to access your funds.

Checking account

A top priority when deciding where to put your emergency fund is ensuring you have easy access to it on short notice.

That’s why Arijit Roy, head of consumer segment and solutions at U.S. Bank, suggests choosing the most liquid type of account banks offer for your emergency fund.

“Those dollars should likely stay in a checking account,” said Roy. “It’s money that is most easily accessible with the least amount of restrictions on transactions.”

Of course, it’s important not to keep your emergency fund so accessible that you fall into the habit of borrowing from it for unnecessary expenses. Avoid temptation by opening a separate no-fee checking account for your emergency fund and keeping the associated debit card stashed in a safe.

While some high-yield checking accounts may offer the added benefit of earning interest, they often have monthly requirements such as a minimum number of debit card purchases. Those restrictions may not be worth the extra returns you might get on your money.

Money market account

Think of a money market account as a hybrid of a checking account and a savings account. They often have interest rates similar to a high-yield savings account, but many money market accounts also allow you to access funds with a debit card, and some let you write checks.

Having easy access can be great when you have an emergency. However, if you struggle to save money, then easy access might work against you.

Some money market accounts have restrictions that may make them less appealing for an emergency fund. These restrictions can include high minimum balance requirements and limitations on how many monthly withdrawals or transfers you can make.

CDs

CDs can earn competitive interest rates, but you’ll have to lock up your money for a set period of time — not ideal for emergency savings. However, there are some ways to take advantage of higher CD rates while still keeping some money accessible for emergencies.

First, don’t lock up your entire emergency fund in a CD. Keep a comfortable amount in a savings account. This way, if you have a smaller emergency, such as a car breakdown, you still have the funds to cover it.

Next, consider building a CD ladder. This consists of opening several CDs with different maturity dates so that you access a portion of your emergency fund every few months. For example, you may decide to buy a 3-month CD, a 6-month CD and a 9-month CD.

This way, you’d have access to one-third of your emergency fund every three months. This could also see you through a larger emergency, such as a job loss.

Lastly, in a real emergency, you can still access your funds even if they’re in a CD, although you’ll usually pay a penalty for breaking a CD before it matures. The penalty amount varies but is typically either a flat fee or a set amount of interest earned.

Roth IRA

One place you may not have considered for emergency funds is a Roth IRA. You can withdraw your contributions from a Roth IRA at any time without taxes or a penalty. You may have to pay taxes and penalties on earnings, but you can withdraw your actual contributions without penalty.

The main drawback of using the money in your Roth IRA for an emergency is that it will affect your income in retirement. IRAs are intended to provide you with financial support when you are no longer working. Withdrawing funds now will impact your security later.

Contributions are limited each year; in 2024, you can contribute up to $7,000 to an IRA. Withdrawing funds does not affect that limit.

For example, let’s say you contributed the full $7,000 to your IRA this year and need to withdraw $1,000 for an emergency. You cannot return that $1,000 later, as your contributions for the year are already maxed out.

For this reason, taking money out of your Roth IRA should be a last resort, but it’s still better than taking it from your 401(k) or traditional IRA, where you would have to pay taxes and a penalty.

Steps to effectively build your fund

1. Set realistic goals. If you’re starting from $0, begin by challenging yourself to set aside just one month of expenses and continue to grow your fund from there.
2. Make saving a habit. Try to make a routine of contributing a portion of every paycheck to your emergency fund until you reach your target balance. Automatic transfers can be a great tool to ensure you’re making regular contributions.
3. Prioritize your emergency fund. Avoid making unnecessary purchases until your emergency fund sits at a healthy balance.
4. Remember that every little bit counts. Even a small contribution is better than nothing.
5. Only use your fund for strict emergencies. If your car breaks down, that’s a great reason to use your emergency fund. A small dent in the side can probably wait.
6. Always replenish your fund. Anytime you need to use your emergency fund, resume contributions until the account returns to its previous balance.

Additional reporting by Ashley Barnett