The fridge started making a funny noise and stopped keeping the food cold. The noise the car makes sounds even more expensive. Let’s not even talk about the coughing noise the furnace made when you fired it up. Issues indicated by noises like those aren’t the only reason to keep an emergency fund. Problems of all kinds can interrupt the flow of your financial situation. Putting money aside as emergency funds reduces the risk of having to go into debt to manage life’s personal finance problems.
Suppose you face a job loss, massive home repairs, or other unexpected expenses. In that case, it’s time to tap into your emergency funds. You probably spent months or even years building an emergency fund, but when it’s time to tap into it, it’s time.
What are Emergency Funds?
The term itself, emergency fund, is pretty self-explanatory. It’s money you use in an emergency. Sure. The less obvious part of this question is, how do you define an emergency? That depends. For some, a new pair of work boots might fit into the category of an emergency in their lifestyle. For most, it’s an out-of-the-norm extra expense, not something foreseeable in the day-to-day.
So, you need some extra cash because something went wrong. The idea is to have that extra cash tucked away somewhere safe that you can access easily. You don’t want to have to pull money out of your RRSP, but you also don’t want to be hiding cash in a cookie jar. As a bonus, there are ways you can get some return on this cash so it will grow some until you need it.
You do have some choices. Some accounts will let you withdraw quickly and grow your cash.
Where Should You Keep Your Emergency Fund?
The first place you should keep your emergency fund is separate from your day-to-day checking and savings accounts. If the balance shows up in your bank accounts, you might end up spending it either by sheer accident or by way of temptation.
Let’s look more closely at some good options for where to keep your emergency savings funds.
- High-interest savings account (HISA)
- Savings account
- Tax-Free Savings Account (TFSA)
High-interest Savings Account (HISA)
High-interest savings accounts (HISAs) offer a higher interest rate than regular savings accounts. This makes them a strong contender for the best place for emergency funds. A higher interest rate, in this case, may range between 1% and 3%. High-interest online savings accounts often have lower rates, around 0.50%. Still, many have no fees and may offer special account opening incentives.
When opening an account, be careful to check the fine print. Are there annual fees? Transfer fees? Minimum deposits? Withdrawal limits? The best HISAs don’t.
In fact, some limit the amount of cash you can take out in any given month. No point in an emergency fund if you can’t take out the amount you need. At the very least, find an account with a large withdrawal limit (maybe even more than your regular account balance.)
If you are already banking online, you can easily open a new savings account in just a few minutes. Most Canadian financial institutions have it set up so that current customers can open a new account without going into the branch. Check the bank’s website or your bank app. If you don’t bank online, just pop into any branch and ask to open an account. You may want to call first because some branches ask you to make an appointment.
Regular savings accounts don’t have withdrawal limits but may have monthly fees. You’ll find higher interest rates in a high-interest savings account, but a regular savings account may be more convenient. Check the fine print to learn the details.
Tax-Free Saving Account (TFSA)
Tax-Free Savings Accounts (TFSAs) are sponsored by the Canadian government. Your contributions grow tax-free because you deposit after-tax dollars. So, your TFSA earnings don’t need to be claimed as capital gains on your income taxes.
Check with your TFSA provider to see if you can open a HISA as your TFSA so you get tax-free earnings and a higher interest rate. You can only put so much into your TFSA, so you may need another savings account for the rest of your emergency cash.
Where Not to Keep Your Emergency Fund
When it comes to emergencies, it’s best to look for liquid, easy access and stable earnings in the short term. Long-term investments like mutual funds, money market accounts or stocks don’t suit the purpose.
You don’t want to keep your funds anywhere that limits your access to your money. Don’t consider your emergency fund an investment! Just set aside a reasonable lump sum to cover unexpected expenses so you don’t have to use your credit cards or borrow from your RRSP.
Ask your bank about opening a no-penalty Certificate of Deposit (CD.) CDs don’t charge you to withdraw funds before maturity. No-penalty CDs have shorter terms with lower rates than regular CDs.
Make Your Emergency Fund Work For You
Experts say to put aside between three and six months’ worth of your regular living expenses. That might take a long time and end up being quite a pile of cash. This can make the process of building an emergency fund daunting and discourage some from moving forward with getting one in place.
To overcome that, many Canadians find success with a starter fund with a reasonable balance based on lifestyle. You don’t need to worry about replacing any appliances if you’re a renter. If you drive a newer, leased vehicle, car repairs probably won’t add up suddenly. Ask yourself what expenses you would use an emergency fund for and decide how much you need based on that.
In the meantime, start with $100 or $1,000 and work your way up from there. If you have debt, consider it as your current emergency. Most experts suggest that paying off debt takes priority over all except a small emergency savings account.
An emergency fund offers you peace of mind and cash when things go sideways. You can focus on solving the problem that caused the financial crisis without worrying about the money.
Prepare yourself for the financial storms in life. Opening a separate account and keeping some cash aside is the first step. With some preparation, you can move towards your financial goals. If your financial situation has you caught between debt and savings, you can talk to one of our credit counsellors. Reach out today to take control of your life and your finances.