Where Should You Put Your Emergency Fund?

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Updated on Wednesday, February 19, 2020

There are three key factors to consider when deciding where to keep your emergency fund: yield, liquidity and cost. Choosing a deposit account to hold your emergency fund that strikes a balance between these elements can help you maximize your savings and provide easy access to the money when an emergency strikes.

Emergency fund basics

An emergency fund is a cushion that protects you against major financial shocks. It’s not for paying regular expenses or even small, unplanned costs. As the name suggests, it’s for emergencies — things like unemployment or major, unexpected medical costs.

Your emergency fund exists to prevent you from having to take on expensive debt when faced with large, unexpected expenses. Whatever type of deposit account you choose for you emergency fund, it needs to provide easy access, a decent return on your money and zero extra costs:

  • Yield: Choose an account with a high interest rate that provides you with a decent rate of return on your money. Keep in mind that your emergency fund isn’t an investment — it’s an insurance policy.
  • Liquidity: You should keep the money in a relatively liquid account so that you can draw from it in an emergency. Highly liquid accounts give you immediate access at no cost, whereas less liquid ones take time to free up funds.
  • Cost: Any extra costs eat into your fund and diminish your returns. Choose an account with zero maintenance fees to help preserve your funds.

How much do you need in your emergency fund? A good rule of thumb is to put away the equivalent of three to six months of living expenses.

Keep your emergency fund in a high-yield savings account

A high-yield online savings account is a great option for your emergency fund. Online banks lack branch locations, which helps lower their overhead costs. This helps them offer higher APYs and lower fees than traditional financial institutions.

Online savings accounts offer varying levels of access to your money. Some offer debit cards and even checks, which let you make payments without delay. Others limit your ability to deposit and withdraw funds to ACH transfers. You can deposit money in many online savings accounts via mobile check deposits, ACH transfers or wire transfers from other accounts. Read the fine print when evaluating an online savings account to ensure you know what your deposit and withdrawal options are.

In addition, savings accounts also limit certain types of telephone and electronic withdrawals, including transfers from savings accounts up to 6 per statement cycle under Federal Reserve’s Regulation D (Reg D). You may be subject to a fee or having your savings account closed or converted into a checking account if you make excessive withdrawals.

Savings account advantages for your emergency fund

  • High APYs: High-yield online savings accounts offer competitive interest rates, which can boost your emergency fund. It’s not uncommon to earn at least 1.70% APY on your balance.
  • No fees: Don’t want monthly maintenance fees or excessive transaction fees to chip away at your fund? There are many high-yield online savings accounts that come with no fees.
  • Low to no minimum balance requirements: Many online savings accounts don’t require their customers to keep a minimum balance, which could be a benefit to people who are just getting their emergency fund started.

Keep your emergency fund in a money market account

A money market account could be a good option for your emergency fund, especially if you’ve already built a sizable balance. You can sometimes find higher APYs on money market accounts than other deposit accounts at conventional banks. However, you may need to maintain a substantial minimum balance to earn interest.

Money market accounts come with a debit card and checks more often than not. This extra degree of access makes it easier to withdraw money and cover emergency expenses on the fly.

Keep in mind that like savings accounts, money market accounts are also subject to Reg D, which limits certain types of telephone and electronic withdrawals, including transfers from savings accounts up to 6 per statement cycle. Factor in any potential monthly maintenance fees and excessive withdrawal fees as you evaluate whether a money market account is the best place for your emergency fund.

Money market account advantages for your emergency fund

  • Easy access to money: The checks and debit cards that come with most money market accounts provide convenient access to your emergency fund.
  • High APYs: Like high-yield online savings accounts, money market funds offer high interest rates.

Keep your emergency fund in a cash management account

Cash management accounts combine some of the best features of both checking and savings accounts, and could be a great choice for your emergency fund. Cash management accounts typically offer competitive interest rates and accessibility that rivals regular checking accounts.

Fintech firms like Wealthfront, SoFi and Betterment offer cash management accounts. Some combine the functionality of savings and checking accounts, while others offer separate savings- and checking-like accounts. Some function more like high-yield checking accounts, with fewer requirements than conventional deposit accounts.

If you’re thinking about keeping your emergency fund in a cash management account, you need to pay close attention to the available features, which can vary widely. Some cash management accounts don’t offer the ability for customers to spend their money with a check or debit card, which could make it tricky to access your emergency fund on a moment’s notice. You may need to transfer the money to a third-party account before you can use it.

Cash management account advantages for your emergency fund

  • Easy access: Many cash management accounts offer debit cards with few to no withdrawal limits. However, some do not — so you need to do your homework before choosing.
  • High interest rates: Many cash management accounts offer APYs that rival the rates of high-yield savings accounts and the best money market accounts.
  • No fees: Few cash management accounts charge monthly maintenance fees that would eat into your emergency fund.

Keep your emergency fund in a no-penalty CD

Certificates of deposit (CDs) pay competitive rates, but in exchange, you agree to leave your money untouched in an account for a set term, such as 12 months. If you withdraw the balance before the end of the term, you are charged an early withdrawal fee equal to some or all of your earned interest. This limitation prevents CDs from being the best place to keep your emergency fund.

Even if you use a CD ladder — a series of CDs that expire at predictable intervals, giving you great rates and slightly better liquidity than single CDs — you still might be facing early withdrawal fees when an emergency hits and you need access to your money.

There is a special kind of certificate of deposit, called a no-penalty CD, that is a potential option for an emergency fund. No-penalty CDs offer good interest rates and don’t charge the early withdrawal penalties that characterize standard CDs.

These accounts usually come with other rules, though. If you need to dip into the account, you may be required to withdraw the full amount — even if you only need a portion of the money. Some no-penalty CDs allow for a fixed number of partial withdrawals and may charge you a fee if you exceed the limit. You generally can’t touch the money at all until seven days after you fund the CD. Most (if not all) no-penalty CDs come with minimum balance requirements.

Advantages of no-penalty CDs for an emergency fund

  • Good, not great, APYs: Some no-penalty CDs offer competitive APYs, but the highest rates are typically reserved for accounts with longer terms and/or higher balances.
  • No early withdrawal fees: Unlike conventional CDs, no-penalty CDs don’t punish you with a fee if you need to take out the money before the term is up.
  • Wide availability: Whether you’re an online banking devotee or you prefer the in-person experience at a branch, you can find no-penalty CDs at financial institutions nationwide.

Keep your emergency fund in a Roth IRA

When thinking about where to store your emergency fund, a Roth IRA might not be the first thing that comes to mind. It’s a retirement investment account, after all. However, Roth IRAs come with some special advantages that make them a potential place you can pull money from in an emergency.

Roth IRAs are funded with after-tax dollars, and you can withdraw the contributions you’ve made at any time you want, without paying a penalty. The earnings, on the other hand, are subject to a 10% withdrawal penalty if you take them out before age 59 1/2 or before the account is five years old.

There are some exceptions to these rules, which can be helpful to know if you’re using a Roth IRA for your emergency fund. You can make early withdrawals without penalty if you lose your job, you need to cover health insurance or medical expenses, you become disabled or you’re buying your first home. You will need to pay tax on the earnings, though.

If you do need to use retirement funds to cover a major emergency, the money in your Roth IRA may come with fewer tax implications than the funds in other types of retirement accounts, like a traditional IRA.

Keep in mind that using retirement funds for something other than their intended purpose could set you back on your long-term savings goals. Try to have another dedicated emergency fund that you can access for unexpected expenses.

Advantages of a Roth IRA for your emergency fund

  • Potential for high returns: Contributions to a Roth IRA can be invested in a wide variety of different asset classes. Pick favorable investments, and your returns could be much greater than would be possible in any deposit account. Of course, poor investment decisions or market downturns could also lead to negative returns.
  • Penalty-free withdrawals: The money you contribute to a Roth IRA can be withdrawn without taxes or penalties under certain conditions.
  • Tax-free earnings: You can spend the earnings from your Roth IRA after age 59 1/2 without paying taxes, as long as the account is at least five years old.

Do not keep your emergency fund in stocks, ETFs or mutual funds

It might be tempting to try to grow your emergency fund by investing in the market via a brokerage account or a robo-advisor. But you might want to think twice about the downsides and potential risks involved in that strategy.

The biggest risk of investing your emergency fund is that its value could decline. Remember, your emergency fund is not an investment — it’s an insurance policy against rare but devastating emergencies. It’s a sum of money you need to be able to count on to provide peace of mind. After you’ve topped up an emergency fund, start investing other funds in a brokerage account.

You can’t predict when you’ll need the money saved in an emergency fund. In a true emergency, you would need to sell your stocks, ETFs or mutual funds — possibly at an unfavorable time, possibly for a loss. It all depends on how the market is performing.

Even if you do sell an investment for a favorable return, you will need to pay capital gains taxes on the earnings. While more favorable than typical income tax rates, the capital gains tax rate could still chip away at the overall amount you have at your disposal for an emergency. Worse yet, you may be subject to a higher tax rate if you don’t hang onto the assets for more than a year.