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Federal health care law affects need for emergency funds

By From page B8 | February 02, 2014

The fact that every household needs cash during uncertain times has become one degree more complicated with the new health insurance situation.

After examining a number of health policies from different providers, I see a clear pattern. Each of us must expect to pay more of the regular costs for health care. The insurance policies are there to protect us from large and catastrophic costs. If you think about having a large deductible on your car or home, the analogy is apparent. You must be financially prepared to cover much of the costs of regular care and the first portion of the high costs associated with hospitalization for major health care.

So how should you adapt your finances to protect yourself? Heretofore, I have recommended an emergency fund for protection against a cash flow crisis spawned by a job layoff, distressed business, major investment loss, extraordinary health care expenses, or some other calamity. You cannot really anticipate these potential damaging financial events.

The new health insurance policies have much higher deductibles and total out-of-pocket costs before the insurance begins to cover the costs. Be prepared. I recommend that you have the annual out-of-pocket maximum amount in addition to your regular emergency fund. This may seem like a large amount, but the crux of the matter is how to manage any health costs which may occur each year.

Remember, the deductible resets each year.

The relevant question is how much reserve cash is appropriate to weather a financial storm. Too much cash is inefficient, while too little cash may turn a short-term cash flow crunch into a long-term financial struggle. Estimating the proper amount of emergency cash is more than academic. Proper liquidity can preserve your credit, buy time for a prudent job search, fund a career change or business start-up, and shelter your family from needless anxiety.

Here are general principles to consider for creating an emergency fund:

  • Determine your spending needs. The family’s monthly budget (not including taxes or business expenses) is an important reference. The size of the emergency fund should be calculated in multiples of the monthly budget. This helps you scale cash flow to actual needs.
  • Gauge your income stability. The more stable your income, the lower the amount needed for how many months of expenses to budget. A commonly suggested amount is six months, but this may be excessive for your specific circumstances. More stability suggests a smaller emergency fund. Less stability increases the needed amount.

Consider these factors:

  • More than one income earner in the family.
  • Different professions, employers, etc.
  • Recession resistance.
  • Job security, seniority, etc.
  • Income certainty (e.g., salary or commission).
  • Job skills and marketability.

Then there are these:

  • Comfort factor. Two months of expenses is probably a minimum. This would apply to someone who could easily find new employment. In extreme situations, you may need 12 months or more of liquidity. Most households fall in the range of two to six months. It could be longer if you anticipate a major expenditure or face greater financial risks, such as high debt, a pending legal settlement or tax bill. There is no formula appropriate for everyone. The most realistic amount is the one that gives you comfort and peace of mind. This is similar to establishing a risk tolerance in your investment portfolio. How much uncertainty can you take?
  • Access to money. Your cash is your first line of financial defense. Easy access is more crucial than interest. A bank account is quite appropriate, as this can provide a high degree of stability and immediate access.

There are other strategies you might explore, such as a home equity line of credit or more sophisticated portfolio structure. Keep in mind that all approaches carry risks that are specific to the asset groups and investment vehicles used.

Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from the University of California, Berkeley. Contact him at [email protected]

Mark Sievers

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