Last week my husband and I had an actual use for our emergency fund. We keep part of the fund as a cushion in our checking account and part in a savings account. Every month we transfer our excess income from the checking to the savings, but we wait until our paychecks, mortgage, and major bills have cleared. Last week was a perfect example of what could go wrong if you don’t have this type of system in place.
Paycheck Errors Do Happen
Last week, the payroll company dropped a digit from one of our paychecks, yet somehow withheld the tax for a full paycheck (nevermind that they’re not supposed to withhold tax at all.) The result was a very tiny paycheck. It was so small that when my husband went to the ATM to withdraw our weekly cash, we joked that we were living paycheck-to-paycheck because he’d just withdrawn more than the paycheck.
Obviously, the error is being fixed, but in the meantime we had a large credit card payment scheduled for payment and our mortgage had already gone through. Because we had the cushion in the account and hadn’t yet transferred the excess to savings, our bills were paid without a hitch.
The Case against Automatic Savings Withdrawals
Many personal finance experts recommend that you set up an automatic transfer from your checking to your savings at the beginning of the month to keep yourself from spending that money. If we had such a system in place, we could have been in big trouble because our large bill payments would have bounced before we’d had a chance to transfer sufficient money back from the savings account.
Instead of setting up an automatic system, we include the deposit in our monthly cash flow chart and schedule the transfer once we’re sure both of our paychecks have cleared and our bills are paid. (Note, the chart in this earlier post has debt payments rather than savings transfers, but we’re out of debt now.) If you can’t trust yourself to do that, allow a five-day lag between your pay day and your automatic transfer to give yourself time to stop it if something does go wrong.
The Case for the Cushion
In addition to implementing a lag, I recommend keeping at least a $500 cushion in your checking account. It’s not there in case you decide to spend extra. It’s there in case you receive unexpected bills or one of your payments goes through twice. This also happened to us several months ago. One of our credit cards somehow got paid twice. Unfortunately, it wasn’t because they accidentally applied our single payment twice. The money came out of our checking account twice, resulting in a large negative balance on the credit card. We could have asked for a refund of the overpayment, but we knew we had a big purchase coming up, so we used the card for it. However, if we hadn’t had our checking account cushion, the second payment could have racked up overdraft fees.
With direct deposit, it’s easy to forget to check your paystubs, but you should always check your online bank balance to make sure you were paid and paid the correct amount. If not, use your cushion or emergency fund until the error is corrected. It’s better than racking up late fees and overdraft fees. And always make sure that everything is in order before you transfer your money to savings. The piddling interest you’ll earn from those extra two days won’t match the time you save not dealing with the bounced payments and fees.
