When you are budgeting and saving, the money in your emergency fund should be earmarked for unexpected expenses.
But what, exactly, counts as an unexpected expense? Some expenses are irregular but predictable, while others are truly impossible to foresee.
Once you understand what unexpected expenses actually are, you will be better able to plan your savings and manage your budget.
Annual Bills vs. Unexpected Expenses
Some expenses do not occur monthly, but you can still predict them because they occur on an annual or semi-annual schedule. They aren't unexpected because you know they will happen once or twice every year.
Annual and semi-annual bills can include:
- Property tax
- Car insurance
- Life insurance
- Eye exams
- School tuition
Even though they don't occur monthly, these annual or semi-annual expenses can still be planned for in your monthly budget. Set aside a fixed amount each week or each month so you have the correct amount saved when the bill comes due.
For example, if your property taxes are $5,200 per year, set aside $100 a week.
($100 a week) x (52 weeks per year) = $5,200
If your annual eye exam and lens replacement cost $300 each year, set aside $25 per month.
($25 a month) x (12 months per year) = $300
Because these expenses are regular and predictable, they are not truly unexpected. You should plan for them in your budget so that you don't have to use your emergency fund to cover them.
Irregular Maintenance vs. Unexpected Expenses
Some expenses are irregular or occur at unpredictable times. But the expenses themselves are not unexpected because they are general maintenance that you can predict will occur at some point.
For example, irregular but predictable maintenance could include:
- Fixing a leaking roof
- Replacing a broken dishwasher
- Paying a $1,000 health insurance deductible
Expenses like medical bills, car work, and home repairs aren't truly unexpected. You might not know exactly when it will happen, or what will need fixing, but you can predict that at some point all these things will need maintenance or care.
To plan for these expenses, your budget should include an estimate of how much you'll spend on variable costs like your home, car, and health.
1% Rule for Maintenance and Repairs
One good rule of thumb is that 1% of your home's value should be set aside each year for home repairs and maintenance. If you live in a $250,000 home, you should save $2,500 per year or about $208 per month.
($250,000 x 1%)/(12 months per year) = $208.33
You won't spend $2,500 every year. Some years you'll spend just $100 or $200 on basic maintenance, like cleaning the gutters. But in other years, you'll spend $7,000 replacing the roof.
The 1% rule is intended to be a long-term annualized average, and you can budget for these types of expenses by setting aside money in a "home repairs and maintenance" fund. During months when you have smaller (or no) expenses, the money will remain available until you have a large expense.
Auto and Health Expenses
The same is true for car and health expenses. If you budget a set amount each month, you'll be able to respond to the average cost of car maintenance and health expenses.
You may choose to set aside $600 a year, or $50 per month, for car repairs. Some years you'll spend $0. In other years, you'll need to spend $4,000 to replace the transmission.
Similarly, you'll need to set aside some money each month to cover deductibles, co-pays, prescriptions, and other out-of-pocket medical costs. The amount you set aside should be aligned with the deductible and maximum annual out-of-pocket costs on your health plan.
For example, let's say your health plan has a $1,200 annual deductible and $5,000 total annual out-of-pocket maximum. If you're healthy and don't visit the doctor often, you might decide to set aside $100 per month, or $1,200 per year.
If you think you may need more frequent doctors visits, you might opt to set aside $416 per month, or $5,000 yearly.
What Counts as an Unexpected Expense?
Your emergency fund should be used for expenses that fall outside the categories of annual bills, irregular maintenance, or predictable health costs. Truly unexpected expenses could be:
- Living expenses for several months after you lose your job
- Unusual medical bills that health insurance doesn't cover
- Plane tickets to attend an unexpected funeral
These expenses are not only irregular and unforeseen, they are related to unexpected or once-in-a-lifetime events, rather than more common activities.
Budgeting for Unexpected Expenses
When you plan your budget to include annual bills and irregular maintenance, you are able to save the money in your emergency fund for truly unexpected expenses.
At a minimum, you should have an emergency fund that can cover three to six months of:
- Rent or mortgage payments
- Car and health insurance
- Car payments
However, just because you have this amount set aside doesn't mean you should stop saving. If your monthly budget is set up to continue adding a small amount per month into your emergency savings, you will be able to plan and pay for unexpected expenses that come your way without falling into debt or missing important bills.