How Much Emergency Fund Do High-Income Earners Need?

Just about everyone has heard about an emergency fund — and why you should have one. But does this conventional advice apply differently to high-income earners?

Who is a high-income earner?

There’s no tried and true definition, but here’s what we need to consider when figuring out who would be considered a high-income earner.

To me, a high-income earner makes enough money to live in the pricier neighborhoods, take vacations and go out to eat without having to worry about whether they can afford it. They may technically live paycheck to paycheck, but they can still “afford” it.

The amount of money to live this lifestyle can vary across the country. Salaries are generally higher in the Bay Area and New York City because the cost of living is higher, for example.

Also, money goes further in some places while not as much in others. Earning $50,000 in San Francisco is barely scraping by while it would be a comfortable wage for someone living in rural Ohio.

The top 5% of earners make around $150,000 nationally, according to tax filing statistics, but there are eight states where it takes at least $250,000 to be in the top 5%. These states also tend to have higher populations, so that stat reflects a significant amount of people.

Taking all of this into consideration, let’s use $250,000 in household income to define high-income earners.

Professionals like doctors, BigLaw attorneys, dentists, certain tech employees, commercial real estate investors, top salespeople and business owners would be the most common high-income earners.

What is an emergency fund?

Traditionally, an emergency fund is three to six months of expenses. The idea here is that you have money to pay for unplanned items and sustain your lifestyle in a crisis without having to call on debt to bail you out.

Keep in mind that the emergency fund calculation is based on expenses, not income.

Let’s say two high-income households take home the identical amount of money — $15,000 per month. One of them spends $8,000, and the other lives paycheck to paycheck and spends $15,000 per month. The couple who spends $8,000 would need $24,000 to $48,000 in their emergency fund, while the couple who spends $15,000 would need $45,000 to $90,000 in cash, almost double despite having the same income.

Think about it this way: a more expensive luxury vehicle would cost more to fix than a Honda Civic if they had the same issue.

The more stuff we have, the greater the emergency fund needs to be. High savers need less for emergencies. That’s why we go by expenses and not income.

What is an emergency?

It’s the unexpected. The unknown. Things that can come out of the blue and rock your world.

Honestly, most of us think of the bad stuff, but there are good emergencies, too. Let’s start with the negative, then go to the positive.

The bad stuff:

  • Losing a job
  • Car breaks down
  • Roof is leaking
  • Air conditioning goes out in the heat of summer — or the heat goes out in the winter
  • A major medical expense
  • You drop your phone in the toilet

But how about the good stuff?

  • Your close friend decides to have a destination wedding
  • Moving to a new and exciting place for a major promotion
  • An opportunity to buy an ownership stake in your company
  • Last-minute tickets are available for that playoff game or sold-out concert

Wouldn’t you want to have money available to take advantage of those opportunities?

Anything can happen in life on the upside or downside, so we need to be prepared. Having cash on hand allows us to jump without wrecking our wealth.

Where should I keep my emergency fund?

This is money that should be available in cash in an easily-accessible checking or savings account. It needs to be liquid so you can get to it the same day.

The wealth optimizers out there (like me) may not like keeping cash lying around earning a paltry interest rate. But then I realized that the purpose here isn’t to make money. It’s to have it available when you need it, kind of like insurance.

Avoid investing the emergency fund in risk assets, like stocks, bonds, index and mutual funds. These assets can fluctuate in value, and there’s a chance it won’t be there for you when you need it.

Also, never use a retirement plan or certificate of deposit as an emergency fund. There could be hefty fees and taxes if you take it out.

Checking, savings and cash is the way to go.

High-income earners have greater financial risk

The average recommended emergency fund is three to six months of expenses. But there are certain factors that might require a person or family to have more cash on hand than that:

  • Only one spouse is a high-income earner
  • Job market volatility in your industry or profession
  • History of health issues
  • Self-employed

Most high-income earners fit into one or more of those categories, so they should err on the side of a larger emergency fund. Loss of income is a huge risk.

Only 2% of jobs pay $250,000 or more. That’s a tiny pool because 98% of jobs can’t replace that income. If a high-income earner loses their job, it could be a long time to make that kind of money again, if at all.

Think about it this way: Let’s say you were making $40,000 and lost your job. That would be unfortunate. But there are a decent amount of jobs and even a combination of part-time jobs that could get your income back up or pretty close to that level in fairly short order if you hustle.

Now what if you’re making $300,000 and you lose your job?  Only a very small percentage of jobs that usually aren’t often available would get you back to that level. You can’t exactly get a job at the local retail store or restaurant to replace that amount of income.

Most high-income earners have larger fixed expenses, too. For example, consider a couple who have two kids in daycare or private school, a $5,000 mortgage and $1,000 or more in car payments. What would happen if one (or both) of them lost their job(s) with no emergency fund?

They’d have to uproot their family or risk losing their house, their cars and switching schools for their kids. That’s pretty scary stuff for parents to think about.

The best way to mitigate high-income earners’ risk is to have a larger-than-normal emergency fund.

How much money should high-income earners have in their emergency fund?

The biggest risk for high-income earners is the loss of their job, then trying to replace that income.

These are highly-coveted, highly-competitive positions because of the pay. Plus, they’re the jobs that most companies cut if the business falls on hard times. Do they fire one person making $250,000 or five employees making $50,000?

Look, no one wants to think about losing a multiple six-figure income. But it can and does happen to people across the board, from those who are self-employed and in control of their own destiny to those who are working in a fairly stable jobs.

The emergency fund serves as a financial protection, and it also helps you have peace of mind. I don’t like to think about dying, but I feel at peace knowing we have adequate life insurance and an estate plan in place. My family will be taken care of, the money will go where it needs to go and we know who would take care of the kids. The courts won’t decide that. My wife and I already predetermined it.

The most important thing is that a temporary career blip doesn’t lead to a drastic life change. The goal, then, is to sustain the “necessity categories” for a full year. That way, if it takes a long time to find a job with a comparable salary or if you have to take a lower-paying job, you’ll have time to make a transition.

Calculating a high-income emergency fund

High-income earners need to be more prepared than the average person. So instead of the conventional three to six months, there’s a better way for high-income earners to calculate their emergency fund.

To calculate the high-income earner emergency fund, take each of these monthly expenses and multiply it by 12:

  • Mortgage payment, including escrow
  • Gas, electric and water utilities
  • Monthly grocery spending
  • Car payment, insurance and fuel for the month
  • Cell phone and home internet bill
  • Monthly daycare, private school and/or activities for your children

In the event that a high income is lost, a person or family can cut back to just these areas and have enough to stay afloat while looking for another high-income job.

Let’s say someone has $4,000 of housing costs, including utilities; spends $1,000 per month on groceries; has $1,000 in car costs; $300 for cell phone and home internet bills and $2,000 per month in kid costs.  That’s $8,300 per month on the necessity categories. They spend about $12,000 per month in total.

The traditional advice would say that a high-income earner would need $12,000 times three to six for an emergency fund. That works out to a range of $36,000 to $72,000 in cash.

But by my calculation, it would be $8,300 times 12, which equals $99,600.

How to start an emergency fund

So you may be thinking, “How do I come up with that money?” The simple answer is to save up.

But although the emergency fund is important, there are other things to take care of first.

1. Pay off credit card debt

Step one is to pay off all credit card debt. Even the 0%-interest cards.

If a high-income earner has any credit card debt, that needs to be paid off before anything else. Here’s why:

Credit card debt while earning a high income is an ominous sign. It means that spending has outpaced take-home pay. Even the slightest decrease in income would be a total disaster and could cause the house of cards to crumble.

If you have credit card debt, get to a point where you’re spending less than take-home pay, and use the extra cash to focus on eliminating credit card debt first.

Reduced spending also means a reduced emergency fund, which is easier to save up, so it would be a double win.

2. Use your employer’s retirement plan-matching program

Step two is to make sure you’re taking advantage of your employer’s retirement plan-matching program. If you put in 6% and they match 3%, that’s a really nice return on your money. This money is locked up until you turn 60, but it’s a great return on investment.

Complete those two steps first.

If you’re already there, take any extra money and build up your savings to the high-income earner emergency fund amount. That’s step three.

At the end of the day, high-income earners should be able to do this fairly quickly if they’re focused.

The benefits of having an emergency fund

Imagine if you had enough savings to pay for a major unforeseen event, good or bad. Would you sleep better? Have a better relationship with your spouse? Perform better at work?

An emergency fund is the bedrock of financial stability. It’s an indication of financial health and provides tremendous peace of mind.

Now it’s time to get started building it.

Take the very first action step today, and simply calculate how much emergency fund you should have. Once you get that number, you’ll have a target to focus on.

Reach out to me and let me know:

  • If you have an emergency fund in place, how has it been financially and/or emotionally beneficial to you?
  • If you don’t have a full emergency fund, what has been your biggest obstacle to get there?

Please email me at rob@studentloanplanner.com. I’d love to hear your answers.

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