How much should an emergency fund be?

What is an emergency fund?

An emergency fund is money set aside for unexpected, urgent costs that cannot be planned for specifically. It is kept apart from everyday spending so that it is still there when something happens.

It is a different thing from saving for a known future cost. A rego renewal, an insurance premium or Christmas can be counted and diarised in advance. An emergency fund covers what cannot be, which is why its size is estimated from your living costs rather than from any particular bill.

How much should an emergency fund be in New Zealand?

Sorted, the money guidance service published by Te Ara Ahunga Ora Retirement Commission, gives this rule of thumb: start with a safety net of $1,000, then build it out to cover three to six months of your expenses.

Sorted also notes that needs vary, that redundancy is the case which drives the three month figure because you need to cover expenses while you look for your next job, and that recovering from a setback while self-employed can take significantly longer, which is closer to the six month end.

It is the starting point for a calculation, not a target handed down to you. Two households on the same income can reasonably land on very different numbers depending on job security, dependants, health, and whether anyone else could help at short notice.

How do you work out three months of expenses?

You add up what it costs to live for a month, then multiply by three. The figure is essential outgoings rather than total spending, because in an emergency the non-essentials are the first things to stop.

As an illustration, if rent is $1,600, power and internet $260, food $700, transport $220, insurance $150, phone $40 and a loan repayment $180, the monthly total is $3,150. Three months of that is $9,450, and six months is $18,900.

Your own numbers are the only ones that matter, and the easiest source for them is your last three months of bank transactions rather than memory. Averaging three months smooths out the weeks with a big shop or a vet bill in them.

• Rent or mortgage payments
• Power, gas, water and internet
• Food and household basics
• Transport, petrol and vehicle running costs
• Insurance premiums
• Minimum debt repayments
• Childcare, medical and other fixed commitments

What counts as an emergency?

Sorted describes an emergency fund as covering unexpected, urgent expenses that cannot be planned for specifically, and lists medical emergencies, car repairs, home repairs, job loss and urgent travel.

Sorted's list also includes unexpected manaakitanga, koha or tangi. That is a real and regular cost in many New Zealand households, and it is often missing from budgeting advice written overseas.

The distinction that matters in practice is unexpected and urgent, rather than large. A $300 cost nobody saw coming can be the thing that pushes a week into overdraft, while a $2,000 cost known about for six months is a different kind of problem with a different fix.

What if three to six months of expenses is out of reach?

For many households it is, and saying so plainly is more useful than pretending otherwise. Sorted's own answer is that any amount of rainy-day money, even $50 stashed somewhere, is better than none, and that it is best to start where you can.

A partial buffer is not a failed emergency fund. The difference between $0 and $400 is the difference between a failed warrant of fitness going on a credit card and it being paid outright, and that difference is real whether or not the total ever reaches three months of expenses.

If the reason it is out of reach is that essential costs exceed income, free and confidential financial mentoring is available from MoneyTalks on 0800 345 123. Using it is a normal thing to do, not a last resort.

Where do people keep an emergency fund?

The two properties people usually look for are that the money can be reached quickly and that it is separate from day to day spending. Those pull in opposite directions, which is the whole design problem: too accessible and it gets spent, too locked away and it is not there when the emergency happens.

Interest earned on a savings account or term deposit in New Zealand is taxed. The bank deducts resident withholding tax before paying the interest to you, at a rate you choose based on your income. Inland Revenue applies a default rate of 33 per cent if you do not choose one, and a non-declaration rate of 45 per cent if you have not given the bank your IRD number.

Paagaa does not recommend particular accounts or providers. Comparing what is available, including the interest rate, any fees and how quickly money can be withdrawn, is something you can do directly with banks or through an independent comparison service.

What happens if you have to spend it?

Spending it is what it is for. An emergency fund that gets used and then rebuilt has done its job, and the alternative was usually debt that would have cost more and lasted longer.

Rebuilding tends to start the same way the fund did, with a set amount moved on payday. Sorted also notes that one-off money such as a tax refund is often redirected into rebuilding a fund after it has been used.