An emergency reserve account is set aside for just that, emergencies. A job loss, a medical emergency, or some other event where unexpected things go wrong. An emergency reserve account is simply a savings account with enough available funds to carry you through a difficult season.
Why is it important to have an Emergency Reserve Account in addition to other accounts? Using retirement or investment accounts in order to help manage through an emergency can create tax consequences and penalties that may have a significant negative effect on your investment and financial goals. Withdrawals from 401(K)s or IRAs can come with a 10% penalty!
How much should one keep in an Emergency Reserve Account? The typical recommendation is between 3-6 months of your salary. Early in a career when obligations are smaller (no spouse or children for example) three months could be enough. Later in life, when obligations are greater, it’s probably better to grow your emergency fund to six months of your salary.
Once your Emergency Reserve Account is funded to the six-month level, then everything beyond your monthly obligations can be directed to other life goals; retirement, travel, education, etc.