Let’s talk about planning for emergencies – specifically, financial emergencies. Do you know how you’d pay the bill if you lost your job, had a health crisis or even just needed a major car repair? Do you have the insurance and the savings you need to get you through tough times? Do you have an emergency fund?

Creating your annual financial plan is a good time to check on your savings for emergencies. Many people fall short, and you don’t want to be one of them.

Planning for Financial Emergencies: America’s Shortfall

According to a report published in May by the Federal Reserve that asked about Americans’ economic well-being in 2015, 18% of Americans experienced a financial hardship last year, and nearly half of that group didn’t have the financial resources to handle it. As a result, people skipped medical treatments they needed, went into debt or tapped retirement funds if they didn’t have the emergency savings to cover their bad luck.

Only about half of Americans have enough emergency savings to cover three months’ worth of expenses, which would help to compensate for a brief period of unemployment, disability or serious illness; the other half might have to sell assets or borrow from friends or family to make ends meet. Even worse, only 54% of Americans could handle a $400 emergency expense with cash or the money in their checking or savings account. Not surprisingly, households with higher incomes are more likely to be able to manage such an expense, but 38% of households earning $40,000 to $100,000 and 19% of households earning more than $100,000 said they didn’t have that $400 on hand. 

According to a November 2015 publication by the Pew Charitable Trusts on the resources families have to handle financial emergencies, a third of American families have no savings, and 10% of households earning $100,000 or more a year also lack them. Additionally, Pew found that the typical household doesn’t have enough liquid savings to cover one month of lost income, and just over a quarter of households could replace a week of income. Even households earning more than $85,000 could only replace 40 days of lost income. 

If most of us don’t have the financial cushion we need, what can we do to increase our financial security? Two safety nets that can help us be more self-sufficient, even in the face of misfortune, are building an emergency fund and getting disability income insurance.

Emergency Fund: How Much Should You Save?

You’ve probably heard the common advice that you should save three to six months’ worth of expenses in case of an emergency. But how much do you really need and why? What is enough depends on each individual’s or family’s situation, according to Kevin Gallegos, vice president of sales and Phoenix operations with Freedom Financial Network, an online financial service for consumer debt settlement, mortgage shopping and personal loans. “Think about the level of expense that causes you to rush to a credit card,” he says. “Is it a car repair bill for $250? A medical bill for $500? That is the amount to start with. Have at least that available and build gradually toward six or more months’ living expenses.”

Six months of living expenses might be a more attainable goal than you think. It’s not six months’ worth of your salary, or even six months’ worth of the amount you normally live on, Gallegos explains: “It is the amount to cover essentials only.” You only need to be able cover key expenses such as housing, food, insurance, health care, utilities, transportation and minimum payments on your debt, not luxuries like vacations, new clothes or restaurant meals.

You might want to have more or less in your emergency fund depending on how stable your income is. If you and your spouse both work for different companies in different industries, you’re less likely to lose your entire household income at once, though it can happen. Also, one spouse could be laid off and the other could fall ill. If you’re a freelancer with an irregular income, you might want a larger emergency fund to help ride out the ups and downs, or you might feel comfortable with a smaller emergency fund because you have multiple clients and are likely to always have some income coming in, unless, again, you get hit with a serious illness or injury and can’t work at all. If you work in a volatile industry with frequent layoffs, that’s another reason to have a larger emergency fund.

Emergency savings are about what you can realistically save, what amount makes you feel secure and what other financial goals you have. You might want to stop at three months’ worth of savings if you have high-interest debt to pay off, then create a larger emergency fund once you’re debt free.

You also don’t want to have so much money in emergency savings that you’re taking away from goals such as saving for retirement. As emergency savings need to be highly liquid, you have to keep that money in a savings account, where it’s probably not even earning enough interest to keep up with inflation. If you have two years’ worth of living expenses in a savings account, you might be better off cutting that amount to one year’s worth and putting the half in a tax-advantaged retirement account, such as a Roth IRA, where you can invest it in exchange-traded funds or index funds and earn enough returns to grow your money over time.

Even if you have an emergency that lasts longer than 12 months, you are unlikely to need that much cash all at once. If you have a 12-month emergency fund and find that you’re still unemployed after nine months, you can start making plans to tap other assets if you can’t find a new job soon, such as withdrawing contributions from your Roth IRA. (For more, see Why You Absolutely Need an Emergency Fund and How to Use Your Roth IRA as an Emergency Fund.)

Disability Income Insurance: What It Covers and How to Get It

Why would you need disability insurance if you’re perfectly healthy and able-bodied? The Social Security Administration (SSA) estimates that more than a quarter of 20-year-olds will become disabled before they reach retirement age. Because of the high risk of becoming disabled and the devastating consequences of being without an income for months if not years on end, disability insurance is a smart purchase.

Short-term disability insurance is designed to cover a disability that lasts six months or less, while long-term disability insurance is designed to cover one that lasts for as long as you’re disabled, until you reach retirement age. This insurance will replace a percentage of your income until you’re able to work again. Some policies cover you if you can’t work in your own occupation, while others only cover you if you can’t work in any line of work. 

Many people have disability income insurance through their employers; others have individual policies. It’s also possible to have both. In 2014, 39% of workers had short-term disability insurance, while 33% had the long-term variety, according to the U.S. Bureau of Labor Statistics. Most workers who have access to disability insurance through work participate in it because their employer pays for it. 

Another source of disability income is the SSA. To qualify, you must have paid Social Security taxes through work. The SSA uses a strict definition of disability: “A person is disabled...if he or she can’t work due to a severe medical condition that has lasted, or is expected to last, at least one year or result in death. The person’s medical condition must prevent him or her from doing work that he or she did in the past, and it must prevent the person from adjusting to other work.”

If you do qualify for Social Security Disability Income (SSDI), the amount you receive probably won’t be enough to cover your expenses, especially given that if you’re disabled, you likely have higher medical expenses than someone who isn’t. The average monthly disability benefit payment at the beginning of 2016 was just $1,166, which the SSA admits is barely enough to stay above the 2015 poverty level.

Besides the fact that SSDI benefits would probably be insufficient to maintain the standard of living you’re used to and are difficult to qualify for, there are other reasons why you might want to carry your own disability income insurance, even if you have an employer-sponsored plan or would qualify for SSDI. “If you purchase your own individual disability insurance, then it is yours, and you own and get to keep it. If you leave your employer, then you lose your DI policy, unless there is some provision to convert it, and it normally costs more,” says Richard P. Sabo, a financial planner with RPS Financial Solutions in Gibsonia, Pa. “Also, if you buy your own and pay the premiums, then the benefits are tax free when you receive them. If your employer pays your premiums for you, then [the benefits] are taxable when you receive them.”

You should apply for disability insurance as soon as possible if you don’t already have this essential coverage (see Choosing the Best Disability Insurance). You never know when you could become disabled, and premiums are cheaper the younger and healthier you are. If you’re in a high-risk line of work, disability insurance is extra important, as you have an above-average chance of becoming disabled.

To buy disability insurance, you’ll need to look beyond the insurance companies you may be familiar with from your auto or homeowner policies; these companies usually don’t sell it. Instead, you’ll find it offered by the same companies that sell life insurance, such as MassMutual, MetLife, Mutual of Omaha and Northwestern Mutual. (For more, see The Disability Insurance Policy: Now in English and Intro to Insurance: Disability Insurance.)

The Bottom Line

To protect against some of life’s major financial emergencies – getting laid off or being unable to work – you need an emergency fund and disability income insurance. An emergency fund is also a great source of protection against minor financial emergencies, such as unforeseen bills; it will help keep you out of debt and keep you from spending money on interest that you’d rather put toward other financial goals.

Annual planning is also a good time to make sure you have a financial and medical power of attorney in place. Power of Attorney: Do You Need One? explains the details.

If you’re exceedingly lucky, you’ll make it through your working years without ever losing your job or becoming disabled. However, most people will likely experience one of these events at least once. An emergency fund and disability insurance will help you make ends meet and keep your stress levels in check, even when misfortune strikes.



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