When budgeting and saving, money in an emergency fund should be set aside for unexpected expenses. But what exactly are those unexpected expenses? Some unexpected expenses may be irregular but predictable, while others really can’t be anticipated.
Annual Bills
Some expenses do not occur monthly, but you can predict them as they happen annually or semi-annually. They aren’t unexpected because you know they will occur once or twice a year. Annual and semi-annual bills can include:
- Property taxes
- Car insurance
- Life insurance
- Eye exams
- School fees
Although they don’t happen monthly, you can plan for these annual or semi-annual expenses in your monthly budget. Set aside a fixed amount each week or each month so that you have the right amount saved when the bill is due.
For example, if your property taxes are $5,200 annually, set aside $100 per week. ($100 per week) × (52 weeks per year) = $5,200. If your annual eye exams and lens replacements cost $300, save $25 each month. ($25 per month) × (12 months per year) = $300.
Since these expenses are regular and predictable, they are not truly unexpected expenses. You should plan for them in your budget so that you do not have to use your emergency fund to cover them.
Irregular Maintenance
Some expenses are irregular or occur at unpredictable times. But the expenses themselves are not unexpected because they are general maintenance that you can anticipate happening at some point.
For example, predictable but irregular maintenance can include:
- Repairing a leaky roof
- Replacing a broken dishwasher
- Paying a $1,000 health insurance deductible
For example, healthcare bills, car repairs, and home repairs are not really surprising. You may not know exactly when they will happen or what will need fixing, but you can predict that all of these things will need maintenance or care at some point.
To plan for these expenses, your budget should include an estimate of how much you will spend on variable costs such as your home, car, and health.
1% Rule for Maintenance and Repairs
A good rule of thumb is to set aside 1% of your home’s value annually for maintenance and repairs. If you live in a home worth $250,000, you should save $2,500 each year or about $208 per month. ($250,000 × 1%) ÷ (12 months per year) = $208.33.
You won’t spend $2,500 every year. Some years you might spend only $100 or $200 on basic maintenance like cleaning pipes. But in other years, you may spend $7,000 on roof replacement.
The 1% rule aims to be a long-term annual average, and you can plan for this type of expense by setting aside money in a “Home Maintenance and Repairs” fund. During months where expenses are lower (or nonexistent), the money will still be available when you need to spend it on larger expenses.
Note that you can keep these savings in a checking account or a high-yield savings account so they can earn interest while you wait to use them.
Car and Health Expenses
The same applies to car and health expenses. If you allocate a fixed amount each month, you’ll be able to accommodate the average costs of car maintenance and healthcare expenses.
You might decide to set aside $600 annually, or $50 monthly, for car repairs. Some years you may not spend anything. In other years, you might need to spend $4,000 to replace the transmission.
Similarly,
You will need to set aside some money each month to cover deductibles, copays, and other out-of-pocket medical expenses. The amount you allocate should align with the minimum deductible and the annual maximum out-of-pocket costs in your health plan.
For example, let’s assume you have a health plan with an annual deductible of $1,200 and an annual out-of-pocket maximum of $5,000. If you are healthy and do not visit the doctor often, you may decide to allocate $100 a month, or $1,200 a year. If you think you may need more frequent doctor visits, you might choose to allocate $416 a month, or $5,000 a year.
Note that you can put the money you set aside for health expenses into a Health Savings Account (HSA) that is tax-free.
What is considered an unexpected expense?
Your emergency fund should be used for expenses that go beyond regular annual bill categories and irregular maintenance or anticipated health costs. Unexpected expenses can truly be things like:
- Living expenses for several months after losing your job
- Unusual medical bills not covered by health insurance
- Airfare to attend an unexpected funeral
These expenses are not only irregular and unexpected, but they also relate to unusual or one-time life events, rather than more common activities.
Planning for unexpected expenses
When you budget for annual bills and irregular maintenance, you can save money in your emergency fund for unexpected expenses.
At a minimum, you should have an emergency fund that can cover three to six months of:
- Rent or mortgage payments
- Utility bills
- Car and health insurance
- Car payments
- Groceries
- Prescriptions
However, that doesn’t mean you should stop saving once you have this amount saved up. If your monthly budget is set up to continue adding a small amount each month to your emergency savings, you will be able to plan for and pay for the unexpected expenses that come your way without falling into debt or missing important bills.
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Source: https://www.thebalancemoney.com/what-is-an-unexpected-expense-453899
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