How much should I put in an Emergency Fund?

Most financial professionals agree that you should have an emergency fund. However, opinions on how much you should keep in that fund vary anywhere from $1000 to 12 months living expenses. So what is the right amount?

What is an Emergency Fund?

An emergency fund is a cash reserve that can be quickly accessed to cover unexpected expenses. Things break, accidents happen, people lose their jobs. It’s inevitable that you will have to pay for something that you didn’t plan for. The question is, when the time arises, will you reach for your credit card or access your Emergency Fund?

How do I plan for the unexpected?

It’s impossible to plan for every scenario, but you can prepare for some of the more common events:

Car Repair

Costs can range from a couple hundred dollars to thousands of dollars for major repairs. Here are some examples:

Source: Auto-Warranty-Group.com

At a minimum, you should save enough to cover insurance deductibles in case you’re in an accident.

Home Damage / Repair

Just like cars, home repairs can range from just a few hundred to many thousands of dollars. Know what your insurance covers and at a minimum save enough to cover your deductible.

Medical Expenses

Medical costs can add up quickly. In 2006 I had outpatient surgery to replace a torn ACL in my knee. Even with insurance I had to pay thousands in out-of-pockets expenses.

Here are some general estimates of how much you can expect to pay out-of-pocket with a standard insurance plan.

• Doctor Visits (co-pay) – $30 per visit
• Prescription Drugs (co-pay) – $10 per prescription (generic), or $40 per prescription (name brand)
• Prescription Drugs (out-of-pocket) – $40 per prescription
• X-rays, CT Scans or MRIs – $300 per procedure
• Laboratory Tests – $85 per test
• Hospitalizations (average – 5 days) – $5,000 per hospitalization
• Out-Patient Surgeries – $2,000 per surgery

Job Loss

The threat of losing your job is a sad reality right now.

• According to the Bureau of Labor Statistics, in December 2009 the average duration of unemployment was 29.1 weeks. That’s up from 19.6 weeks in December 2008.
• Most states pay unemployment benefits up to 26 weeks. Congress recently extended those benefits by 14 weeks, up to 20 weeks for the states with the highest unemployment, for a total of 40-46 weeks.
• How much you collect is based on your previous earnings up to a maximum level. For example, in California the maximum you can collect weekly is $450.
• The first $2400 in benefits are tax-free. Anything you receive above that is considered taxable income.

If you were receiving health benefits from your employer you will now need to cover the cost of health insurance. According to USA Today, the average health insurance policy for a family of four costs $13,375 or $1114/month. So your unemployment benefits can cover your monthly health insurance premiums, but not much more.

Natural Disaster

What if cash was worthless or couldn’t be accessed and food and water were the new currency, as is the case right now in Haiti. Are you prepared beyond your bank account?  Frugal Dad posted an interesting article that explores the idea of broadening your Emergency Fund beyond cash reserves to include supplies and food reserves. These supplies will extend your cash supply in case you lose your income or to double as emergency supplies in the event of a disaster.

So what’s the right amount?

I don’t think there’s a magic number that covers everyone. But considering the events and associated costs I’ve outlined, and taking into consideration your personal situation such as health, job security, local job market, etc. you can determine the right number for you.

Our number is somewhere between 8-12 months living expenses, that’s where our comfort level is. We’re currently up to 3.7 months so we have a ways to go but we contribute faithfully each month and I expect to hit 8 months by September. I’ll also be taking Frugal Dad’s advice and increase my stock of emergency supplies.

What’s your number? What amount gives you peace of mind?