Friday, April 22, 2011

Do you have money put aside in case of an emergency?

From the 1970s through to the 1990s, this was a no-brainer, as interest rates were relatively good on the usual savings vehicles — high-interest savings accounts and Canada Savings Bonds. But in the last decade or so, interest rates have dropped to record lows, credit has become more easily available, and we have started expecting portfolio returns significantly higher than an emergency fund would generate.

So it's understandable that the emergency account would disappear from a lot of people’s lives.

In the current economic climate, credit has been tougher to obtain and unemployment rates are rising rapidly; EI pays very little compared to many people's spend-what-you-earn lifestyle, and using a home equity line of credit in a period of declining real estate values is neither wise nor likely possible. Thanks to all that, an emergency fund is an absolute must in these economic times.

The main reasons for creating an emergency fund are to provide protection in the event of a layoff; to provide cash in the event of a sudden disability or illness requiring time off work; and to provide funds for any other possible emergency (e.g. a new roof for the home, a new furnace, car repairs, etc.).

What's in a fund?
Creating an emergency fund does not mean investing aggressively in an equity portfolio and selling when the going gets good — the money needs to be safe and secure. It should also be liquid, so that you can get easy access to your cash if need be, but it shouldn't be so accessible that it can be frittered away.

Saving grace

While this account won't be the one you use to save up for that expensive house on the beach, the more you can save the better. Still, make sure that you know that the fund isn't designed to provide money for non-essentials such as entertainment, vacations, gifts or eating out. It is designed to ensure that you can maintain a roof over your heads, put food on the table and maintain payments for essentials.

Figuring out how much you need to save requires answers to a few questions, as the amount of savings depends to a large extent on individual situations. What is your level of debt? Do you have dependents? Is your spouse employed at the same company? Is your occupation one for which there is usually a demand, so any period of unemployment is likely to be short term? Or will you be faced with the possibility of retraining in another field, which will mean substantial time and financial costs? Do you have other investments of a sufficient amount that you could access if need be? Do you have family who would be likely to help out? The general rule is that you should have at least three to six months of living expenses in your emergency fund.

Goodbye Taxman

Until the advent of the tax-free savings account (TFSA), the amounts saved in these rainy-day funds always generated interest that was fully taxable. The TFSA provides a great savings vehicle for an emergency fund and there will be no tax on the interest! With a couple both building savings of $5,000 per year each in a TFSA, there will be a solid basis of an emergency fund right there. If you feel the RRSP is more important, taking the tax refund generated by the RRSP contribution and putting it into the TFSA allows accumulation of assets that are all tax sheltered.

Tax Time is Approaching

The deadline for filing your Canadian tax returns (unless you or your spouse owns a small business) is April 30th. The deadline for paying outstanding personal tax bill for everyone is April 30th. Have you started getting ready?

A couple of suggestions:
- Check your tax return for last year to make sure that you have included everything. I had a call from a client last week who did not receive his tax receipt for an RRSP contribution. (We’re assuming that it was lost in the mail.) It is your responsibility to file your taxes with the information from all of your slips.
- Even if you don't owe taxes, you should file your 2010 income tax return by April 30, 2011 to be eligible for some tax credits and benefits, such as the GST / HST tax credit, , the Canada Child Tax Benefit, the Universal Child Care Benefit, and the Children’s Fitness Tax Credit. I have a client (she’s a union employee and last year with all the odds and sods received almost $3000 back from the government. True, most was overpaid contributions.
- You can access your tax information on the Canada Revenue Agency web site using the My Account. This year, you will need a CRA user ID and password to use the service. If you don’t already have one, click on the No button to create one

Canada Revenue Agency lists a number of common ways Canadians can reduce their tax bill. Check it out.

If you have specific questions, perhaps I can help you out – or at the very least, steer you in the right direction.