How To Earn More Interest On Your Emergency Savings

November 29, 2018

My wife and I were driving home from dinner not long ago and we were stopped at a traffic light. BAM! Someone hit the rear of our car, making our memorable evening out a little too memorable. No one was hurt, but the offending driver was a little slow to produce credible insurance proof, so I had my insurance company handle the repairs initially.

Since I like to keep my monthly premiums as low as possible, there went $1,000 out of our emergency fund for the deductible. A week later, someone backed into the side of my parked pickup truck and made a quick getaway, leaving me stuck with another insurance claim – and another $1,000 deductible out of my pocket. Ouch.

You probably keep some cash set aside for emergencies too, right? I hope you’ve squirreled away somewhere between three and six months of expenses into a savings account for those surprise expenses that life throws at us. Financial planners almost universally recommend this strategy as the preferred way to avoid taking on expensive credit card debt (or worse – payday loans).

Earning more on your emergency savings

Even though we know having cash on hand is the best way to handle these emergency expenses, the minuscule interest rates on savings accounts makes it difficult to watch all that cash just sit there and do practically nothing else for us in the meantime. Surely, there is a better way? Actually, there are several better ways to earn a few extra bucks on your extra (emergency) bucks. Let’s take a look at a few alternatives.

Credit unions & community banks

If you do your banking at one of the big commercial banks, you’re probably not earning much interest at all on your savings. For your emergency fund, look around for a credit union or small regional bank alternative in your area. Having worked in the credit union for several years, I admit to some bias here, but I also have plenty of facts to support my bias. For instance, as I am writing this, a well known large bank’s website currently shows interest rates on their savings accounts to be a whopping 0.01%. Yes, that’s one one-hundredth of one percent.

At that rate, you would have to keep $1,000 (one thousand) in your savings account for a whole twelve months to earn one single penny. My local credit union, on the other hand, pays 0.25% on their regular savings accounts and 0.30% on money market accounts. Still not that much to brag about, but significantly better – 25 times better! They also offer a special rate on youth savings accounts, paying a whopping 2.96% on balances up to $500!

The lesson here: shop around for specials. Sometimes community banks and credit unions are seeking additional deposit dollars (so they can make more loans) and will pay you pretty handsomely for the use of your money.

Online only banks

If you don’t mind doing your banking business online instead of face-to-face in a local brick & mortar building, the world of online banking (and their lower overhead costs) might be a good fit for you. Keeping your emergency funds just out of arm’s reach might also help you avoid raiding the piggy bank for non-emergencies.

A good place to shop around for online bank savings rates is www.bankrate.com. As I look there today, I see interest rates on savings accounts as high as 2.10%, with a minimum deposit as low as one dollar. CD rates are as high as 2.60%, but you must commit those dollars for at least one year to enjoy that rate. In any case, online banks are worth taking a closer look!

Roth IRAs

I am often asked if a Roth IRA makes sense as a type of emergency savings. My response to this question is both yes, and no.  As you may know, IRS rules do allow for early distributions from a Roth IRA as long as the amount you take out is not more than what you have already contributed (i.e., don’t touch the earnings). So, technically, yes you could tap into your Roth IRA to cover an emergency expense, but I don’t recommend using this as your primary emergency money.

Short term cash needs (emergencies) should come from liquid, short term cash, and you will find those funds in your savings account at the bank or credit union. Roth IRAs are for longer term needs, such as supporting you in retirement, and as such, these funds should be invested in longer-term things (stocks, bonds, mutual funds, etc.) that can grow at a rate better than what a savings account pays. As such, your Roth IRA is not suitable as an emergency fund – except maybe in this next instance.

Consider it as your “back-up” emergency fund

Suppose you already have three months of critical expenses covered by cash in your savings or money market account.  Then – and only then — you might consider your Roth IRA as a backup emergency fund for really big emergencies, such as an extended bout of unemployment or an expensive medical procedure with steep out-of-pocket charges.