According to a recent article in MoneySense nearly two-thirds of Canadians have built an emergency fund. That’s great, but means that one-third of us have not.
For those of us is in that bottom third, an emergency fund is designed to cover “unexpected expenses, such as urgent major repairs (not renovations) to your home or car, unexpected medical expenses not covered by universal healthcare or insurance, or lack of income due to job loss,” MoneySense explains.
As many of us are finding out during this bizarre year 2020, without an emergency fund, these unexpected expenses are being covered “with a credit card… payday loans, or heavily using your unsecured line of credit,” the article continues. All of these are high-interest options, and the interest piles up if you can’t pay the money back in full.
Some folks also raid their retirement savings to pay the bills, a strategy that can backfire at tax time or in the distant future when you’re trying to leave the workforce – more about that later.
MoneySense recommends we all set aside enough money to cover “three to six months’ worth of fixed expenses.” OK, so we know the what and the why – let’s turn to the how.
An emergency fund, the article suggests, should not be set up like a retirement savings account. “Saving for an emergency isn’t about long-term goals, increasing your wealth, or planning for retirement, it’s about having immediate access to cash,” the site advises.
MoneySense recommends that you first create a budget to see how much you can set aside each month. That amount should be invested in either a TFSA or a high-interest savings account, the article notes. “Disconnect the account from your debit card so you won’t spend it,” the article advises. Automate payments so you don’t “forget” to make them, MoneySense says. “Pay yourself first.”
At Manulife’s website, the advice is similar. An additional idea on how to build the emergency fund is to cut back on costs – “think about how much you spend on coffee, lunches out, and other impulse purchases. Give up one or two things and week and stash that money into your savings,” the site suggests.
They also reiterate the idea of making savings automatic – treat your emergency fund “like a bill… the sooner it’s saved, the less time you will have to spend it.” Manulife also warns against the dangers of analysis paralysis – start small, say $10 a week or so, and ratchet things up as you go along.
Sun Life covers much of the same ground, but warns against using debt as an emergency fund or tapping into retirement savings.
“All withdrawals from RRSPs (except for education and home purchases, under the Lifelong Learning Plan and the Home Buyers’ Plan, respectively) are subject to income tax and will result in the permanent loss of contribution room – that is, once you’ve taken it out, you can’t put it back in. Any withdrawals from your RRSP are immediately subject to withholding tax,” Sun Life explains.
“If you withdraw up to $5,000, the withholding tax rate is 10 per cent. If you withdraw between $5,001 and $15,000, the withholding tax rate is 20 per cent, and more than $15,000, the rate is 30 per cent. These tax rates apply in all provinces except Quebec, where provincial tax rates apply on top of the federal withholding tax,” the Sun Life article warns.
So to recap – create a savings account that isn’t hooked up to any of your cards, and automatically transfer money into it regularly. Keep the money in some sort of high-interest savings account so that it remains liquid, and ready to spend when an emergency arrives. You don’t want to risk losses here.
Think of it as an obligation, like a bill, that you have to pay each month. Then set it and forget it, until the next emergency comes along.
And if you’re busily automating your emergency fund savings, think about doing the same thing for your Saskatchewan Pension Plan retirement account. Have a pre-set amount earmarked for retirement automatically withdrawn from your bank account every payday. That way, just as is the case for a well-designed emergency fund, you’re paying your future self first.
Written by Martin Biefer
Martin Biefer is Senior Pension Writer at Avery & Kerr Communications in Nepean, Ontario. A veteran reporter, editor and pension communicator, he’s now a freelancer. Interests include golf, line dancing and classic rock, and playing guitar. Got a story idea? Let Martin know via LinkedIn.