Most financial experts suggest saving three to six months of household expenses to help with emergencies. But with record inflation, this task has become much more difficult to accomplish because virtually all safe places to put your emergency funds will not provide interest rates that keep pace with inflation. But that doesn’t mean you can’t increase the rate of return on these funds.
Here are some ideas for reducing the impact of inflation on your emergency funds.
Actively monitor the rate of your savings account. Earlier this year, the Federal Reserve raised interest rates for the first time since 2018. Furthermore, the head of the Federal Reserve suggests that there could be several such rate increases over the next 12 months. . This should increase the interest you can earn on the money in your emergency account.
What do you want to know: Not all savings accounts are created equal. When the Fed raises the interest rate, your savings account rate should also rise…immediately. But it’s not always the case. If your bank is slow to increase your savings rate, be prepared to monitor and transfer funds to a bank that does. Just make sure the funds are still FDIC insured and held at a reputable bank.
Take a look at Series I Savings Bonds. Series I savings bonds are issued and guaranteed by the US government and have two interest rate components: a fixed rate and an inflation rate. The fixed rate is fixed when the bond is issued and never changes during the life of the bond. The inflation rate is reset semi-annually based on the consumer price index.
What do you want to know: You must hold an I bond for at least 12 months before redeeming it. And while you can repay it after a year, you’ll have to pay a penalty equal to the previous three months’ interest if you repay the bond within five years. And remember, you must be prepared to pay the penalty if you need the funds for an emergency.
Creative use of Roth IRA funds in an emergency. Roth IRAs are funded with after-tax dollars. Therefore, the early withdrawal of the initial contribution is exempt from tax and penalty. However, if you tap into the income, you will not only be subject to income tax, but you may also be subject to a 10% early withdrawal penalty.
What do you want to know: Using a Roth IRA is often a creative way to fund your emergency account while earning higher returns with conservative investment choices, but it’s not for the faint-hearted. Getting it wrong could cost you taxes, penalties and loss of fund value in a bear market. Before withdrawing funds from any IRA, it makes sense to conduct a tax planning session.
Please call 425-640-8660 if you have questions about how to reduce the impact of inflation on your emergency fund.
— By Nancy J. Ekrem, CPA
DME CPA Group PC
Chartered Accountants and Business Consultants