A TFSA account can be a war chest in the event of a major emergency, such as job loss or prolonged disability.
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If you don’t have emergency funds, you are living dangerously. And a line of credit is not the answer.
You build an emergency fund by putting your money where it is more difficult to withdraw it. Forget about checking or savings accounts, whose interest rates are usually lower than inflation (so you lose money).
You can choose a high interest savings account. I personally prefer those from virtual banks (Achieva, Alterna, Hubert, La Capitale, Manuvie), which are more generous.
But the return in these accounts is added to your taxable income. However, if it is modest, this solution is essential if you reserve your TFSA for important matters, such as your children’s post-secondary studies, renovations or simply your retirement plans.
For example, a 3% return on an amount of $ 8,000 is $ 240. From a tax perspective, there is nothing to write to his mother if it is in a high interest account.
The TFSA is malleable
The TFSA, however, has certain advantages. Most important: the returns are tax-sheltered. And if you make a withdrawal, you don’t lose your contribution room, unlike an RRSP. You can therefore contribute again when your situation is stabilized.
As you are investing for an emergency fund, choose low risk assets, such as fixed income securities (mutual funds or bond ETFs). This approach has a flaw: overly conservative investments are not ideal for your retirement. To make the right choices, consult a financial advisor.
A good emergency fund
What is the acceptable emergency fund? It should cover your financial obligations (bills, payments, shelter, food, retirement savings, etc.) for three to six months.
How to constitute it? By automatic transfers of small amounts with each pay. Let’s say you need $ 7,500 to survive a quarter: if you transfer $ 73 with each payday, it will take you two years to build it up.
- While waiting to build your emergency fund, a home equity line of credit (average rate of 3%) is better than a personal line (average rate of 9%) or your credit cards (19%). But it requires discipline not to abuse it.
- Check your disability coverage: is that from your employer or your financial institution (mortgage insurance) sufficient to cover your needs? Is it too expensive? Should you have additional insurance? Consult an insurance advisor.
- Never use your RRSP as an emergency fund, as withdrawals are taxable immediately and at a high rate (at least 10% if it’s over $ 5,000).
- You can deposit up to $ 6,000 in 2020 into a TFSA account. And you can contribute more with unused entitlements from previous years. If you’ve never had a TFSA since 2009, you could suddenly contribute $ 69,500.