How are emergency funds different from savings accounts – and why does everyone need one?

It’s important to note that an emergency fund is not the same as a savings account. It’s a separate pool of money designated specifically to cover or offset expenses associated with an unforeseen situation.

Life can really throw some curveballs. You’re doing great managing your day-to-day finances. You’ve even managed to build a respectable retirement fund. But then something unexpected happens – a medical emergency, leaky roof, car repair, job loss or any number of catastrophic surprise expenditures that could derail even the most prudent financial plans.

Whether you emerge from one of these unfortunate situations financially sound or in financial ruin is largely dependent on what steps you took in advance to prepare for the proverbial “rainy day.” Sadly, less than half (43%) of all Americans have the funds available to pay an unexpected $1,000 expenditure from their savings. Even more concerning, one-fourth say they would charge the expense to a credit card and pay it over time, thus incurring interest that would further dig them into debt.

The goal is to save enough to keep you afloat for several months, but the important thing is to just start saving. If you can’t put away $500 per month, aim for $100 or even $50. Every little bit helps. Because you may need to access the funds at a moment’s notice, it’s imperative they can easily be withdrawn without penalty. Don’t invest emergency funds in a certificate of deposit (CD) or IRA. Choose an interest-bearing savings account instead.

As your emergency fund grows, resist the temptation to tap those funds for everyday expenditures or fun discretionary spending, like a tropical vacation or a flashy new sports car. If an emergency arises, however, don’t be afraid to make use of your emergency fund. After all, that’s what it’s there for. Just remember to replenish those funds once you have your finances back on track. As soon as you are able, resume saving for that rainy day because there’s definitely going to be another one – maybe sooner than you think. 

Emergency savings vehicles become a valuable employee benefit

The once-in-a-lifetime COVID-19 pandemic, followed by 40-year-high -inflation, shone a spotlight on the need for emergency savings and how woefully unprepared many people were to handle unexpected expenditures. Not only did employees recognize the need to take action and establish or build upon an existing emergency fund, they also began looking to their employers for help. According to the 2022 Alight Hot Topics in Retirement and Financial Wellbeing report, more than one-third (35%) of employees say their employer should provide a tool to help them with their emergency funds, up from 23% just two years prior. Perhaps even more telling, the number of respondents saying employers helping workers with an emergency fund was “nice but not necessary” fell from 36% to 30%.

Recognizing how detrimental such behavior could be to individuals’ long-term financial security, Congress included two emergency savings provisions in the new SECURE 2.0 retirement law. Beginning in 2024, plan sponsors may permit non-highly compensated employees to make Roth after-tax contributions to a special “side-car” emergency savings account within the retirement plan. The first four withdrawals each year will be tax- and penalty-free and contributions to the account will be capped at $2,500. It’s great that legislators are focusing on the problem. However it falls far short of the six-months of living expenses most individuals need to have a sufficient emergency fund.

Increasingly, employers are looking to offerings like our Alight Financial Path¹ solution. It gives employees access to tools and financial advisors who will analyze their situation. These resources will help them achieve the right balance between paying down debt and saving for a rainy day. Through part of our partnership with SoFi, Alight now offers an emergency savings benefit that differentiates the organization and serves as an attraction and retention tool. Employees gain access to an emergency savings vehicle with preferred interest rates, no fees and no cap and the possibility of an employer match or other savings incentives.  

¹ Financial Planning is offered through Alight Financial Advisors, LLC (AFA). AFA is a registered investment adviser and wholly owned subsidiary of Alight Solutions LLC.  Financial Advisors are Investment Advisor Representatives of AFA. AFA and its affiliates do not guarantee future results. AFA's Investment Advisor Representatives do not provide legal, accounting or tax advice, nor do they provide investment advice in connection with the Financial Planning service. Financial Planning does not constitute a solicitation or offer to buy or sell securities and is a separate service from AFA's investment advisory services. Alight Solutions LLC, AFA and their affiliates are not responsible for errors or omissions or for the results obtained from the use of any information provided. In no event shall Alight Solutions LLC, AFA and their affiliates be liable for any indirect, special or consequential damages in connection with the results of your use of this information.