Emergency Fund vs Life Insurance: How to Prioritize Your Financial Safety Net

Dependent income earners should prioritize term life insurance. For singles without dependents, build an emergency fund, then secure your term life insurance policy, and then save to cover three to six months of expenses. Most should realize and implement both strategies at the same time, rather than making this a choice of one to do forever and neglecting the other. Typically, those seeking the emergency fund vs. life insurance answer are more interested in the order of importance of the two strategies.

Understanding Both Tools

Both tools have the same general function, but the protection they provide is different. Knowing how each one works will help you decide where you want to place your money.

Both of the tools you are considering have a function of protection, but they protect against different things.

The Emergency Fund

An emergency fund is money set aside for those ‘just in case’ moments. Unexpected costs like job loss, medical costs, or repairs on the house can be financially crippling if you don’t have a safety net. Emergency funds cover the costs of living so you don’t have to rely on credit or loans.

The goal is to save three to six months of your ‘committed expenses;’ those are costs like your mortgage, groceries, minimum debt payments, etc. It’s best to aim for six months if your income is unpredictable. You never know when you might lose your job.

Money in an emergency fund should be in a ‘high yield’ savings account because you might need the cash within a few days and you want to make sure that the money is safe and does not lose value.

Life Insurance

When you purchase life insurance, especially term life, if you were to die, your family would receive a death benefit. Income tax is usually not applicable. This helps provide the amount of income you would have otherwise provided for loved ones in order for them to continue to pay for necessities such as mortgage/rent, groceries, and funds for education.

If you happen to be the main source of income for your household, you’ve got to have this protection for your family. If you don’t have this protection, your family runs a very real risk of losing their home and being forced to go without other necessities at one of the worst and most difficult times they’ll ever have to endure. Stay at home parents also need coverage for the cost of services that they perform for the family such as childcare and housekeeping.

Which Comes First: Emergency Savings or Life Insurance?

The answer is unique to everyone. There are many factors to consider like dependents and the stability of your income and savings. Generally, the answer to the question “Emergency savings or life insurance first?” accounts for if anyone relies on your paycheck. While there are many possible configurations, here are two of the more common examples.

When Life Insurance Should Come First

There are some instances in which one should definitely make life insurance their priority. If you have children or a spouse that is financially dependent on you, then you should make life insurance your first priority. In fact, in some cases life insurance should be treated as more important than the emergency fund. The impact of a death is permanent. $1,000 (aka emergency fund) may have a band-aid effect on a problem like a broken-down car, whereas it will not replace several years’ permanent debt like a mortgage.

Buy a term life insurance policy as soon as you can to take advantage of the best rates while you are still young and healthy. Use that time to your advantage to build the emergency savings. A healthy 35 year old is quoted ~$25-40 per month for a $500,000 20 year term policy. A comparable policy in whole life can average 7-15 times that of a term, which means most families will select term over whole life to finance large cash value.

When Emergency Savings Come First

If you have no dependents or significant consumer debt, begin your emergency fund with around $1,000. Unexpected minor expenses, like a car repair or medical expense, can leave you with high interest debt you may not be able to get out of.

After you hit this milestone, buy a low cost term life insurance policy since someone relies on you. Then continue to save three to six months of expenses. For those with a variable income, this can be stretched to six to twelve months.

A Simple Decision Guide

Answer these 3 questions

1. Do you have dependents who need your income to survive?

If yes, get life insurance. If no, set up emergency fund first.

2. Do you have any money saved currently?

If yes, go compare insurance quotes. If no, save $1,000 first as a starter fund.

3. Is your income consistent and stable?

If yes, save, minimum, three months of expenses. If no, save six months of expenses.

Finally, if you answered yes to question 1, you need to get a life insurance quote for term insurance before anything else today.

How Much Life Insurance Do You Need? The DIME Method

The easiest method to approximate a value is what we refer to as the DIME method (manage your debt, income, mortgage, and educate the family).

Consider our example case of a 35-year-old who earns $50,000, and who is married with one child. First, some rough calculations:

Debt (car loan & credit cards): $50,000

Replacement income for five years: $250,000

Remaining mortgage: $250,000

Education for one child: $120,000

Total: $670,000

For someone this age, healthy or not, this type of policy might cost about $40 to $55 per month. This is probably less than several subscription services that people pay for, such as streaming services.

An emergency fund of $5,000 will last about six weeks. After that, the family would have to face the mortgage not getting paid and foreclosure. With the Policy of $670,000, the mortgage would be paid, replacement income would be provided, and the family could cover the education costs.

Balancing Emergency Fund and Life Insurance

You don’t have to choose between the two. Balancing an emergency fund and life insurance can happen when you pay into both at the same time. In fact, I would argue that it works better when one of the two payments is smaller.

An easy way to practice saving in general is to use the 50/30/20 rule. 50% of your after-tax money should cover your needs (everything from rent to insurance). 30% can be spent on wants (going out to eat, hobbies, etc). The last 20% is reserved for saving and can be split however you wish between the emergency fund and retirement. Insurance premiums should really be classified under needs because they are protecting your family.

There are four general steps used to build the safety net that actually works. First, audit your expenses so that you know how much you have to spend each month. Second, get life insurance quotes so you know the expense. Third, set up savings with automatic withdrawals and premium payments as automatic. The last step would be to do a complete and total audit of everything you have in one year because your finances and family will most likely change.

A Few Things Most Articles Skip

With term life insurance, the death benefit is paid during the no waiting period. During the two-year contestability period, the insurance company can look into your case to decide whether they will pay your benefit if you die because of illness. They can deny your claim if they find that you provided false information. No matter what, accidental deaths are covered from day one.

Most riders added to an insurance policy have their own waiting periods. A critical illness rider would not cover if a diagnosis was made within the first 90 days. Disability riders have a waiting period of 90 days before benefits begin.

Cash-value life insurance is not an emergency fund. Whole life insurance is a much bigger out of pocket cost than term life, and the fees that drain the early cash value make it more of a long term investment. A savings account that earns interest and is backed by the Federal Deposit Insurance Corporation is a better emergency fund.

What to Do at Each Life Stage

Young professionals should consider developing an emergency buffer and an affordable term life policy. Young life insurance rates will lock in at a lower cost and help you maintain your insurance eligibility in the future.

Both life insurance and an emergency buffer is probably necessary for any parents or homeowners. Your emergency buffer should cover at least six months of your mortgage.

Stay at home parents should consider life insurance as well to protect the value of your unpaid work. Replacing your work would be expensive to your family.