So, how do you start an emergency fund?
- Create and analyze your monthly budget to see what you can afford to put aside in savings
- Set aside a certain amount each month or each paycheque
- Set up either a Tax-Free Savings Account (TFSA) or High-Interest Savings Account (HISA)
- Disconnect it from your debit card so you won’t spend it
- Pay yourself first
- Automate those payments
1. Set a monthly budget and find out what you can set aside each month
- Choose your budget tracker of choice. It could be Excel, an online tool or an app of choice
- Collect receipts, bills and pay stubs for the past six months. Some expenses will be the same amount each month (mortgage, rent, credit cards), while others might change depending on usage (hydro, entertainment, food, transport)
- Enter those numbers into the budget (if numbers differ monthly, use the average)
- Be as accurate as you can–look at the information you’ve added and adjust, add or subtract as needed
- Review your budget to see if there are any categories where you can spend less (some budget apps offer suggestions where you can cut back)
Some experts suggest saving 10% of your salary, but if that’s difficult, start by saving what you can, even if that’s $10 to $20 a month. TFSA savings accounts and high-interest savings accounts offer a higher interest rate than traditional savings accounts, so your money can compound at a higher rate over the same period of time.
If you have debt, you’ll want to pay that off as quickly as possible because the debt’s interest rate is higher than the earn rate on your emergency fund. That way, once you’ve paid off the higher-interest debt, you can redirect that money towards your emergency fund, which should feel pretty easy to do, because you’ve already developed the habit of saving money.
2. Choose the right savings account for an emergency fund
Where should you put your emergency fund? There are two ideal options: inside a TFSA, or a regular high-interest savings account.
Tax-Free Savings Account
A TFSA is a registered investment or savings account that allows you to invest in a number of different instruments, including ETFs, stocks, bonds and cash, for tax-free gains. The amount of money you can deposit is limited to $6,000 per year, to a lifetime maximum total contribution amount of $69,500 as of 2020. Any amount you don’t use in a given year remains available to you going forward, so it isn’t a “use it this year or lose it” situation.
TFSAs are very flexible and are the best option for an emergency fund because you can use them for any short- and long-term savings goals, and you can make tax-free withdrawals. (RRSPs, on the other hand, require you to claim any withdrawals as income.) TFSA savings accounts can also offer a higher interest rate than the average savings account, currently around 2.0%.
Compare the Best TFSA Savings Accounts in Canada