Having an emergency cash reserve that you can rely on makes dealing with rainy days in life much easier. Whether it’s an unexpected home or car repair, or an unplanned visit to the vet or doctor, your emergency fund can help cover the costs, but where should you keep your emergency savings?
High-Yield Savings Accounts
High-yield savings accounts are distinguished by several features that set them apart from traditional savings accounts. First, high-yield savings accounts tend to offer a higher annual percentage yield (APY) on deposits, as their name suggests. What this means for you is that your money earns more interest over time.
Another important difference is that high-yield savings accounts may carry fewer fees than regular savings accounts. For example, you may not pay a minimum balance fee or a monthly maintenance fee.
Where can you find high-yield savings accounts? They can be offered by traditional banks, but you may find more variety when looking at online banks instead. The pros of opening a high-yield savings account with an online bank include:
- You might have a higher APY on savings compared to traditional banks
- Lower fees, if any
- Lower minimum deposits (some online banks allow you to start saving with as little as $0)
There may be downsides to choosing a high-yield savings account for your emergency fund, especially if you decide to take advantage of an online bank. The biggest of these downsides might be convenience. If your emergency fund is with an online bank and there are no branches or ATMs nearby, you may have to transfer money from your savings account to an account at a traditional bank and then make the withdrawal. This could be inconvenient if you need the money quickly.
Money Market Accounts
Money market accounts may be similar to high-yield savings accounts in terms of annual percentage yield and monthly fees. There are some differences that might make them an even more appealing option as one of the best places to keep your emergency fund.
Unlike regular savings accounts, money market accounts may come with debit card access and check-writing privileges or both, depending on the bank you are dealing with. This can make a money market account very convenient if you need to make an emergency purchase or write a check to cover an unexpected expense.
One potential drawback is that money market accounts may require a higher minimum deposit to open. For example, you might need $100 or more to open an account. This may make a money market account out of reach, at least in the short term until you can build up your savings cushion.
Certificates of Deposit (CDs)
Certificates of deposit or CDs are time accounts and function a bit differently than high-yield savings accounts or money market accounts. A certificate of deposit requires you to commit to leaving your savings untouched for a set period. This period can range from 30 days to 10 years, depending on how long you choose for the certificate of deposit. Once this period is up, your certificate of deposit matures, and you can withdraw the initial deposit, along with the interest earned.
The positives of using a certificate of deposit for your emergency fund are that you may be able to achieve a higher return than even a high-yield savings account or money market account, and CDs generally do not have monthly maintenance fees. A downside, however, is the penalty imposed for early withdrawal if you take out money from the certificate of deposit before its maturity date. This penalty can be a flat fee or a percentage of the interest earned.
Method
To overcome fees, one approach is to create a ladder of certificates of deposit, using multiple CDs of varying lengths. For example, you might have a three-month CD, a six-month CD, a 12-month CD, and an 18-month CD. The advantage of a CD ladder is twofold. First, you have CDs with staggered maturity dates, making it easier to access funds if needed without incurring a penalty. You can also take advantage of higher yield rates since generally, the longer the term of the certificate, the higher the interest.
Roth Individual Retirement Account (IRA)
A Roth individual retirement account is a tax-advantaged way to save for retirement but can also serve as an emergency fund in times of need. The beauty of a Roth account is that your money is invested in the market, which means you can earn a much higher rate of return compared to a savings account or even a certificate of deposit. Qualified withdrawals from a Roth IRA are always 100% tax-free.
Using a Roth IRA for emergency savings may not be the optimal solution, however. Depending on how long you’ve had the account and your age at the time of withdrawal in an emergency, you may be subject to taxes on the earnings you withdraw, along with a 10% early withdrawal penalty. You’re also reducing your retirement savings because the money you withdraw is no longer benefiting from the power of compound interest.
Consider a Multi-Faceted Approach
If you’re hesitant in determining the best places to keep your emergency fund, consider using more than one option. Split some emergency cash into a high-yield savings account, some into a money market account, some into a certificate of deposit, and some into your Roth IRA. This way, you’ll have multiple options to cover an emergency when an unexpected surprise arises.
Source: https://www.thebalancemoney.com/best-places-to-keep-your-emergency-fund-4179049
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