How long could you stay afloat if you lost your job? Two months? Six? A year? Two?
And how would you pay the bills? Go into debt? Dip into your RSPs? Sell your home?
Could you sleep at night? Would you panic?
These aren’t easy questions. It’s not nice to think about losing your job or having an illness that prevents you from working, but Tannis Dawson, a High Net Worth Planner at TD Wealth, wants you to think about your worst-case scenario. That’s because they actually happen and many of us are not prepared to deal with a financial emergency. What we all need to have, she says, is a plan for when our finances have capsized and we’re flailing as we are pulled under.
Few of us plan for life’s misfortunes, says Dawson, as most people think that a disruptive financial event may never happen to them. It’s that kind of thinking that can allow us to ignore negative situations until it’s too late. But consider the number of Canadians who find themselves in financial quicksand every year. One recent poll suggests that 46% of Canadians are only $200 away from not being able to pay their bills each month and Statistics Canada reports that our savings rate is near an historical low of 1% of our income.1,2 Moreover, statistics show that 57,000 Canadians declared bankruptcy in the past year and more than 73,000 people made offers to creditors to settle debts in negotiated conditions.3
What everyone needs to consider, Dawson says, is an emergency fund large enough to get you through three months without a pay cheque. That’s not the same as extra money in a savings account: These are funds you consciously need to build up just for life’s unexpected curveballs, and should only be tapped in serious situations. An emergency fund can help you get through a crisis and help get your finances back to where they should be less painful.
“Those living beyond their means, the people who are living pay cheque to pay cheque — it doesn’t take much to be knocked off the rails — it may only take an interest rate hike,” she says.
If you haven’t thought about what you would do if your financial plan gets unexpectedly derailed — or even what you might do should the furnace break the same week the roof begins to leak — now may be as good a time as any. Here are some thoughts on how to build an emergency fund, when to use it, and what you can do to get your finances back on track once you’ve tapped into it.
Building an emergency fund
Dawson says that an emergency fund can not only help see you through a short-term crisis, it can help deal with the stress of losing your income due to unemployment or illness.
For example, the lack of a solid plan for financial setbacks could cause people to make poor choices that can make a bad situation worse, such as turning to a high-interest lender. Having an emergency fund can give you breathing space.
Dawson says she works with clients to build structured but flexible plans that can help them meet their wealth goals and life ambitions. And part of helping to make sure people reach their goals is having contingency plans standing ready when you have a temporary setback.
In her opinion, an emergency fund equivalent to three-months’ salary is often the target amount to be socked away. The reason? In the case of unemployment, there may be a delay before Employment Insurance benefits kick in and of course finding a new job may take some time.
However, accumulating three-months’ salary doesn’t happen overnight and getting there requires a plan in itself, she says. Individuals may wish to shift financial priorities and build a fund over other non-essential spending, especially if their employment situation seems unstable.
One option to consider: Set aside small amounts over time to build up the fund. For example, setting aside 5% of your pay cheque (after tax) over seven years could help you accumulate an equivalent of three-months’ salary. You might consider setting up an automatic transfer to a separate savings account to help you get this fund going. You can time it to your regular pay cheque. That way you’re paying yourself first.
When to use your emergency fund
Not building an emergency fund and dealing with money woes on top of that can take a toll on your mental well-being. You may be forced to borrow money wherever you can. You may make drastic financial decisions before you actually have to. But Dawson explains that some ways of getting money are smarter than others when you need to pay bills. For instance, credit cards are convenient, but interest rates will only compound financial problems if you can’t pay off your card in full by the end of the month.
Dawson offers this hierarchy of options to consider when trying to find money in an emergency:
1. An emergency fund: Ideally three months’ salary earmarked specifically for a gap in pay cheques. It could tide you over for short-term problems like the loss of a job.
2. General savings: If you have liquid or near-liquid savings, you may consider accessing these funds before withdrawing any interest-earning investments.
3. Tax-Free Savings Account: Your TFSA might be tied up in investments so it may take some time to turn it into cash. But remember that if your TFSA is part of a larger investment plan and you collapse it, your investments may need to be adjusted.
4. Home Equity Line of Credit: Once you dip into your HELOC, or any other line of credit, you begin paying interest on whatever you draw out.
5. Retirement Savings Plan: An RSP is meant for your retirement years so it really should be a last recourse. Also, making withdrawals can produce new problems as it solves others because you are required to pay taxes on those withdrawals. Dawson also points out that, when you do get back on your feet, you may need to save at an even greater rate than before to make up ground on your retirement goals.
Dealing with insurance
One of the areas that may get overlooked if you find yourself suddenly unemployed are insurance issues. If you have benefits with your company, disability and life insurance and health benefits may be covered by your employer. However, when the job ends, benefits might stop while the need for insurance continues. That can add another financial burden to your situation. Dawson says people should carefully consider their situation and, as a preemptive strategy, consider buying insurance outside of their employer’s plan.
An emergency fund and critical care and/or long-term care insurance can also work hand-in-hand when you are vulnerable. Having a fund if you are suddenly without income means you are able to keep paying premiums on these important policies. And if you do become ill, these policies can offer financial support.
Getting back into shape
Once you’ve tapped your emergency fund, one question you may ask is: How will I get back on track? A new budget may be required because the situation dictates that the frills of life are cut back and people have to only pay for the necessities of life.
“Budgeting is very important. People should see their advisor and see what can be done. And sometimes it’s hard to decide where to cut back, especially when someone is used to a certain lifestyle,” she says.
Dawson says that speaking with an advisor can help develop a new budget during these situations and for the next phase: returning your finances back to where they were.
She says getting back on your financial feet even when a pay cheque has returned can be tough. An individual may have dipped into savings or incurred debt to make ends meet. If funds were removed from an RSP, catching up on funds could take some drastic measures, especially if the timeline to retirement is close at hand.
According to Dawson, an individual may have to expand their RSP contributions, adopt a more aggressive investment outlook or work a few years beyond their desired retirement date.
Whatever the situation is, Dawson says an advisor can help you preemptively plan for an emergency that hopefully never happens. And if someone is in a crisis situation or is trying to recover from one financially, an advisor can offer smart alternatives to help you get back on track more quickly.
- Grant Bazian, “Canadians significantly more worried about debt, interest rates and personal finances compared to September,” MNP LTD., Jan. 21, 2019, accessed July 23, 2019, mnpdebt.ca/en/blog/canadians-significantly-more-worried-about- debt-interest-rates-and-personal-finances-compared-to-september.↩
- Beata Caranci, “Tariffs Impart a Chill Wind on Green Shoots,” TD Bank, June 17, 2019, accessed July 23, 2019, economics.td.com/ca-quarterly-economic-forecast.↩
- “Insolvency Statistics in Canada,” Statistics Canada, April 2019, accessed July 23, 2019, www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/br04100.html.↩