Facing unexpected events in your financial life can be incredibly overwhelming. If you are not adequately prepared, the immense burden of expensive medical bills, lost income, or other sudden setbacks can be finally devastating. Six months into the COVID-19 pandemic, chances are that this sentiment is even more relatable than usual.
So, what can you do to protect yourself and your family from suffering the negative consequences of such events? Building a financial safety net is a great place to start. This will help you continue to meet your financial obligations if you find yourself in a bind with money.
Knowing you have this safety net can afford you peace of mind, empowering you to focus on tackling whatever difficulty you are facing while also providing for your loved ones.
With this in mind, here are three actionable steps you can take to build the right financial safety for your unique needs.
Develop a robust emergency fund
It’s not always the big expenses that cause the most financial stress. Oftentimes, it’s the smaller, unexpected expenses that cumulatively can wreak financial havoc.
According to SmartAsset, the median checking account balance in the U.S. for those under age 35 is $1,200. For the age group 35-44, it is $2,000. Based on these figures, a large car or home repair bill can quickly deplete the average checking account.
For example, the cost of a transmission repair can easily exceed $2,500, including parts and labor. This amount is more than many people can pay cash for, so they resort to using credit cards with high-interest rates to make payment. This only adds to their debt load and increases the amount of financial stress they carry with them.
Having an emergency fund provides the cash-on-hand needed to pay unexpected expenses, and reduces or eliminates the need to rely on credit. Most financial experts agree that having 3-6 months of living expenses stashed away is considered a healthy emergency fund (although there certainly are situations that may call for up to 12 months).
It’s important to remember that this is an account that is funded over time and withdrawals are made only when absolutely necessary. It is not a “put-and-take” account.
If you are ready to begin saving for emergencies, bear in mind that it won’t happen overnight. Any amount you can start with is acceptable. For many people, it can take several years to accumulate enough savings to cover most unexpected financial needs. So as you get started by putting aside what you can, remember to be patient with yourself.
If you’ve already started your emergency fund, make sure to stick with it. You’ll find it well worth the sacrifice if you need to tap into this fund down the road.
Contribute to a reliable retirement account
Many people think of their Individual Retirement Account (IRA) or 401(k) accounts only in terms of providing money for when they retire. While that’s certainly the goal, these accounts can also provide funds in case of emergencies.
According to the Internal Revenue Service (IRS), there are three ways you can access funds from your retirement account before you reach age 59 ½.
- Hardship distributions. Money can be taken out from a retirement account due to “immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need.” Taxes must be paid on the distribution, and the funds received are not paid back.
- Loans. Some employers include loan provisions in their retirement plan documents. If you borrow from your account, you must pay the loan back. The money taken is not taxable if the loan meets the plan’s rules, and the plan’s repayment schedule is followed.
- Early withdrawals. This would be a last resort when it comes to accessing money in your retirement account. In addition to paying regular income tax on the withdrawal, it may result in a penalty of 10% of the amount withdrawn if you are under age 59 ½.
No one starts putting money aside for their retirement with the intention of accessing the account before they retire. But unforeseen expenses, like massive medical bills not covered by your health insurance, can justify tapping into this money earlier than planned. Having a reliable retirement account is another important element of a financial safety net.
Secure ample life, health, and disability insurance
Insurance is something no one wants to pay for. But the truth is, It’s something that everyone needs. In addition to homeowners and auto insurance, here are three types of coverage you will want to consider.
- Life insurance is vital for the security of family members in the event of your death. It provides the funds necessary to ensure that your family can remain in their home, have day-to-day needs met, and receive the education you intended for them. Having life insurance for your spouse is also important for a dual-income family to meet the same needs, or for a stay-at-home parent because it will pay for child care expenses while the surviving spouse is working.
- Disability insurance is among the most important types of coverage you can carry, but it’s often overlooked. Your personal disability policy will replace a portion of your monthly earnings if you become too sick or hurt to work for an extended period of time. Think of it as financial protection for your greatest asset — the ability to earn an income and provide for yourself and your loved ones.
- Health insurance pays for what is potentially the most devastating of financial events, the major illness of yourself or a family member. According to HealthCare.gov, the average cost of a three-day hospital stay is around $30,000. Without adequate health insurance, this could be enough debt for them to need to declare personal bankruptcy.
- Critical illness insurance helps cover what your health insurance doesn’t. If you are diagnosed with cancer, heart attack, stroke, or another covered condition, your individual critical illness policy will provide a lump-sum cash benefit up to $75,000. This is money to use however you want. Pay health insurance deductibles and copays, replace lost income, cover everyday living expenses — pretty much whatever you need.
As you can see, insurance is an essential part of any financial safety net. Ultimately, how much coverage you need depends on the type of lifestyle you lead.
Final thoughts
These three elements are the foundation of a strong financial safety net for you and your family. While no financial plan is perfect, putting money aside and protecting yourself financially is well worth it. The sooner you can get started developing an emergency fund, contributing to a retirement account, and finding ample insurance coverage, the better off you and your loved ones will be in the long run.
