The best place to stash your emergency fund

In our April 2016 issue of MoneySense, we introduced you to Lindsay Tithecott, a 29-year-old who is trying to pay down debt, build up savings and buy a larger condo. Throughout the year we’ll be giving her a financial challenge every two weeks to help her get her finances in tip top shape.She’s already been challenged to cut her fitness expenses as well as to determine if she should prioritize debt-repayment over saving. Lindsay’s third challenge was all about condo-buying and the various aspects associated with that process. Make sure to follow along!

Challenge No. 4

Lindsay:

After doing the first three challenges I felt I wanted some face time with my financial expert. So I arranged to have a 30-minute phone chat with certified financial planner Heather Franklin, the expert helping me along my Money Fit journey. My four questions were:

1. What amount is ideal for emergency savings?

2. Where should my emergency savings be held? Outside a TFSA? I’ve always kept my “emergency money” within my TFSA in a GIC that can be cashed out within several business days. If I need money before the funds are freed up, I plan to use my line of credit as a bridge.

3. Right now, I keep $5,102.13 in “Reliance LP 4.574% 15Mar17” within my TFSA and that is my “emergency fund” for now. The $3,121 in the EPOCH mutual fund is more of a holding fund for me. Each month I contribute to my TFSA and RRSP. The monthly contribution goes into the EPOCH. When the amount hits $5,000 I sell and buy a chunk of stock. Most recently I bought Howard Hughes Corp. But would it be better to keep the holding money in cash rather than the EPOCH?

4. My RRSP limit this year is about $3,000, which got me to thinking. My new employer pulls my contribution and their match, and deposits it into my RRSP prior to paying tax. Does it still count as an RRSP deduction even if the contribution was made directly and I haven’t paid tax on it?  (Or have I?) When I get the RRSP contribution income-tax slip annually, it doesn’t split the contribution up between my half and the employer’s half. Do I claim the total amount or just the half that is my money? Is my $3,000 limit my contribution and my employer match combined? Or just my half?I’m going to have to watch my contributions this year so I need to get a handle on this now. I also had a terrible time with my tax accountant and have to get them to redo a few things. If they have to redo this as well I’d like to know before I go back to them.

What the expert says

Lindsay’s emergency fund should consist of enough money to cover at least three months of living expenses. “This money can be held in a variety of places and a TFSA is a good place to hold it,” says Franklin. “She should hold it in a fixed income ETF instead of a GIC. It’s just easier to access.”

Franklin says she knows that a line of credit can also act as an emergency fund but she hesitates to use this method in Lindsay’s case—at least until the outstanding $11,000 balance has been whittled down significantly.

Lindsay’s priority at this time should be paying down the line of credit balance. “Instead of earmarking her monthly savings for investment, Lindsay should be directing her energies to debt reduction,” says Franklin. That’s because debt reduction is a form of savings. In fact, reducing debt is one of the best savings strategies. Through paying down your debts, you effectively earn a rate of return equal to the interest rate charged on the debt, immediately.

Regarding the EPOCH mutual fund, Franklin says that if this is a “placeholder” for monies that will be invested at a later date, she recommends that Lindsay simply hold this money in cash. “That way, the money isn’t at the mercy of short-term fluctuations to the downside,” says Franklin. “And rather than purchase a new stock with every $5,000 accumulated, once her debt is paid off, she may want to consider adding to her existing blue-chip stocks.”

And finally, Lindsay’s income would support an RRSP contribution limit much higher than just $3,000 annually. “The dollar contribution limit is just that, a limit. That’s a combined amount from all sources,” says Franklin, who goes on to explain that the matching contribution is actually considered a taxable benefit and will be noted as such on Lindsay’s T4 that she receives from her employer. She’ll also receive a contribution receipt from the plan administrator which will contain both her personal contribution and the company matching contribution. Consequently, Lindsay will be able to deduct the company match portion as an RRSP contribution. “Lindsay should definitely discuss the issue with her Human Resources department. They should be able to clarify any misunderstandings.” And finally, Franklin advises Lindsay to put a call into the Canada Revenue Agency (CRA). “The reps there are knowledgable and very helpful.”

The lesson learned?: The process was beneficial to Lindsay in that she realized she must rein in her expenses and tackle her debt before increasing her investment savings or buying a newer, bigger condo.