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Making Use of Windfall Payments for Emergency Savings

Catherine New-Financial Health Network

Catherine New

Editor, Emergency Savings Initiative

Helen Robb-financial health network

Helen Robb

Senior Manager, Financial Health Network

Windfall income can be a good opportunity to shore up emergency savings. Making good use of them comes down to this one thing.

If you found yourself with a surprise $500 in your hands tomorrow, what would you do with it? This is more than a thought experiment, it’s actually a mini-financial planning session. Knowing how you’d divvy up a windfall ahead of time is a good way to make sure that money helps you — rather than hurts — by becoming a lost opportunity. As we enter the season of tax refunds, work bonuses, and other payments that are not part of your regularly scheduled work income, it is a good time to spend some time planning ahead for what you’re going to do with that money. On the tax front, chances are you will get something back from the IRS — over two-thirds of Americans filing tax returns got a refund and the average amount last year was over $2,000.

Behavioral research tells us that people tend to struggle with making the most of irregular income, like tax refunds or other windfalls. Why is that? The human brain tends to see sudden income as “free money” and doesn’t give it a full value to your financial health. But since our brains also don’t pre-allocate a windfall to day-to-day expenditures like groceries, bills or adding to savings, there’s a big opportunity to change that.

Research also tells us that planning ahead and re-committing when the money comes in, works to make sure you know where that money is going. It could be as easy as saying out loud, “Next time I get $500 outside of my normal income, I’m putting it into my emergency savings account.” That kind of pre-commitment tells the little accountant sitting inside your brain that the money has real value to you and you have a plan in place when you get it.

In practical terms, this could also be something like setting up automatic deposit to savings for your tax refund or asking someone to hold you accountable to your commitment to saving your next chunk of money.

The value to you of building emergency savings goes far beyond seeing a nice balance in your account. By saving for an emergency, you could actually be also saving yourself a whole lot more down the road. New research[1]  from the Financial Health Network examined how starting to save impacts financial health in different ways beyond just growing an account balance. Sure, that money might be able to cover the immediate emergency but there’s a positive domino effect — it also saves you from having to take out an expensive loan, carry a balance on your credit card, or risk things like not being able to pay for food or housing. A finding from our research showed that people who started to save for an emergency in the last year had a 6 percent lower chance of experiencing hardship (e.g. food or housing insecurity).

Of course, you know your finances best — your windfall plan might also include paying bills, making an important purchase, and building an emergency savings account. But the important thing is that you think about a plan now, so when that good fortune of a windfall comes your way, you’re ready to do the right thing for financial health.

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