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Emergency Money

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Free in 30! -> Emergency money

Emergency Funds

Tax Free Savings Accounts (TFSAs) are a good alternative to an RRSP to use for emergency funds that are not necessarily last resort funds.  If you're in a low tax bracket, it also may be good to use the TFSA until you are in a higher tax bracket, and then make a transfer to an RRSP.  The main disadvantage of TFSAs for emergency funds is that they are easy to access, so you might spend the funds when you really shouldn't.  See our article on TFSAs vs RRSPs.  However, if you have high-interest credit card debt, you should pay off this debt before putting money into an emergency fund.

Keep emergency money (last resort funds) in an RRSP

Everyone should have money saved for an emergency.  This emergency fund is not for getting the car fixed or buying a new TV.  It's not for braces for the kids or for their university education.  It's not for your trip around the world or your Ferrari, or even for buying a house.  This is last resort money, for disasters only.  When you can't find a job, your employment insurance is used up, the kids are starving and your house is being repossessed, now you can use this money.  Also, if you are struck with a debilitating injury or illness, you will have funds available to ease your financial distress.  Hopefully you will never have to spend this money, and it will give you peace of mind for your entire life.

When you are young, you don't really need an emergency fund, because your parents support you.  Once you are on your own, a small emergency fund will probably be sufficient, because  if a disaster strikes, you may be able to move back in with your parents.  Once you settle down, have a spouse, and consider having children, you should do some financial planning.  The financial plan must include enough emergency money to last 6 months to a year.

When you are young and saving money, you are probably saving for a holiday, clothing, computer, or maybe even a car.  Before you spend your money, you should think about your future, and allocate some of your savings to an emergency fund.  Although you may not need an emergency fund at this time, it is best to start saving money when you are young, because the longer it is invested, the more it will grow due to compound earnings.

Once you start working, even part time, you should open a Registered Retirement Savings Plan (RRSP), and start depositing your Pay Yourself First money (or more) into the RRSP.  The reason we recommend putting the emergency money into an RRSP is:

bullet the contributions are tax deductible, therefore you can put more money into an RRSP than a TFSA, and still have the same amount of money left to live on.
bullet you will have more money in an RRSP than if you put the same after-tax money into a TFSA.
bullet when you take the money out you won't be working, so you will probably be in a low tax bracket.
bullet you are less likely to withdraw the funds for non-urgent reasons than if it was more accessible.

Tax Tip:  Feel secure by having emergency funds!

Tax Tip:  Nobody plans to fail - they just fail to plan!

Your financial plan should include the following steps:

  1. Pay yourself first!
  2. Emergency money
  3. Define your goals
  4. Personal budget
  5. Buy a home
  6. Get out of debt
  7. Save and invest

 

Revised: April 10, 2016

 

 

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