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Building a financial safety net means putting savings buffers in place so you can cope with unexpected costs or income shocks.
Unfortunately, as most of us know only too well, life rarely goes exactly as planned, so it’s important to consider how you’d manage financially if something were to go wrong.
A worrying number of people don’t have any kind of protection or savings in place, leaving them with little financial resilience if they become ill or have an accident and can’t work. Few of us are fortunate enough to be able to manage without an income, so having savings or protection to fall back on can provide valuable peace of mind.
Here’s what you need to know.
What is a financial safety net?
A financial safety net is a blanket term for a set of measures aimed at protecting your finances from life’s uncertainties, whether that’s an unexpected tax bill, a car breakdown, or not being able to work.
Financial safety nets differ from person to person but they can be a combination of all sorts of financial products, including savings accounts and insurance policies. We cover the different options available in more detail below.
Why is having a financial safety net important?
Having a financial safety net is an important step in building financial resilience, and should mean you’ll be better able to manage unexpected situations or emergencies.
Here are some of the reasons why it matters:
- Life is unpredictable: Redundancy, illness, relationship breakdown or caring responsibilities can arise suddenly, often without warning.
- It reduces stress and anxiety: Knowing you have money set aside can provide peace of mind during uncertain or difficult periods.
- It buys you time. A safety net gives you breathing space to make thoughtful decisions, rather than being forced into quick or poor choices.
- It protects long-term plans: Having emergency savings can prevent you from dipping into pensions, investments or taking on expensive debt.
- It supports health and wellbeing: Financial pressure can be a major source of stress, which can affect both physical and mental health.
- It helps you stay independent: Having your own financial buffer can reduce reliance on family, friends or credit.
- It’s especially important later in life: As income becomes less flexible, a safety net can help manage gaps between work, benefits and pensions.
- It can make it easier to weather wider crises: Steep living costs, economic downturns or changes to benefits can hit quickly and hard.
What are the different types of financial safety net?
There are various approaches you can take to build a financial safety net, but generally, most people will include either savings accounts or insurance policies, or a combination of these:
1) Savings accounts
Experts usually recommend trying to save three to six months’ worth of income as an emergency fund to fall back on.
The type of savings account that people choose often depends on their goals, and the features and flexibility that they need. There’s no right or wrong, as long as you can access your money quickly.
Two popular types of savings accounts for creating a rainy day fund are instant access savings accounts and notice accounts with a short notice period.
Instant access savings accounts
As the name suggests, instant access savings accounts are popular as you can access your money quickly if you ever need it.
You can discover current best buys in our articles Best instant access savings accounts.
Notice accounts
Some people, however, find an instant access savings account is a little too tempting to dip into, so a notice account with a short notice period, or one which limits the number of withdrawals you can make, can be a good option too.
Learn more in our article What are the best notice savings accounts?
Top 5 Easy Access Accounts
2) Insurance policies
There are several types of protection policy that you can take out, including:
Life insurance
When you take out a life insurance policy, you’ll pay monthly premiums, and if you die, the insurer will pay out a lump sum to whoever you’ve nominated as a beneficiary. This provides your partner and/or dependents with a financial cushion if the worst happens.
More than half (63%) of homeowners and around a third (29%) of renters have life insurance in place, according to insurer Royal London, making it one of the most common types of insurance policy people have.
Generally, you’ll find that the younger you are when you take out your policy, the cheaper your premiums will be, as there’s less chance of a claim being made during the policy term.
Whilst it’s not a legal requirement to take out life cover at the same as a mortgage, it is advisable if you want to ensure that the mortgage will continue to be paid in the event of your death. You can read more about life insurance in our article Life insurance for over 50s explained.
Critical illness cover
Critical illness cover is a type of insurance that is designed to pay out a tax-free lump sum if you are diagnosed with one of the serious illnesses or disabilities predefined in the insurer’s policy.
This type of cover runs for a set term of your choice. The types of conditions that critical illness usually covers will vary depending on which insurer you go to. However, they normally include illnesses and disabilities that are long-term such as some cancers, heart attacks and strokes, as well as multiple sclerosis and Parkinson’s disease.
One key thing to be aware of with critical illness cover is that some conditions might not be covered, so you need to read the small print carefully before taking out a policy. Read more about critical illness cover in our guide Everything you need to know about critical illness cover.
Income protection
Income protection, as the name suggests, is designed to provide you with a regular income if you’re unable to work because you’re unwell or have had an accident or injury. Redundancy is not usually covered by this type of policy.
Of all the insurance policy types listed here, income protection is the least common option with only 20% of homeowners and 6% of renters having this kind of cover, according to Royal London. This is despite there being a higher chance that you’d need to make a claim for this type of policy than any of the others.
Again, you’ll pay monthly premiums and in the event you have to make a claim, the insurer will usually pay out a percentage of your salary each month, typically around half. You’ll be paid this amount until you’re well enough to go back to work, or until you retire or pass away, whichever happens first.
For more information on income protection insurance, have a look at our guide Income protection explained.
How big should a financial safety net be?
The size of the financial safety net you need will depend on your circumstances, but generally, making sure that you can cover your basic living costs, such as property costs, bills and food shops, for three months is a good target.
You can read more about this in our article How to build an emergency fund.
How can I build a financial safety net?
The best way to get started with a financial safety net is by mapping out a budget and working out how much you can realistically set aside each month after paying your mortgage or rent, bills, food costs and debts, if you have any. This is sometimes easier said than done, so if you want some tips on making a budget that you’ll actually use, have a look at our guide How to make a budget and stick to it.
Once you’ve worked out how much you can afford to put aside for your safety net each month, the next steps you take will depend on how big you want your net to be.
You’ll also need to consider how quickly you want it to grow and whether you want to open a savings account, take out an insurance policy or both.
Remember, there’s no right or wrong way to build a financial safety net, so it’s important to take the approach that works for you.
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