Can a TFSA be used as an emergency fund? (Video)

Written by Tangerine

Monday, December 8th, 2014

 

 It absolutely can be, and a lot of people initially use a Tax-Free Savings Account as an emergency fund, but later see it evolve into a long term investment portfolio.

While the name “Tax-Free Savings Account” implies that it’s a savings account, it can actually hold investments too, like mutual funds, stocks, and bonds. As long as you stay within your overall contribution limits, you can have multiple TFSAs. For example: one for easily accessible cash, like for an emergency, and one for longer term investments.

First, it’s important to remember that if you carry a balance on your credit card, or have any other sources of high interest rate debt, you’ll want to tackle those first. You wouldn’t want to be paying more interest on your debt than you would be earning on the emergency fund. If you do carry high-interest debt, you may not want a large emergency fund yet – perhaps just a few hundred dollars in case there is any interruption in your income. You’ll want your focus to be on getting rid of those credit card balances first.

Now, if you don’t carry high-interest debt, then yes, a TFSA is a great option for your emergency fund. Too often, people will use a regular banking account for their emergency fund, but the problem is that it’s too easy to withdraw money from a regular account and spend it for purposes that aren’t emergencies.

By using a TFSA, your savings is one step removed from your regular banking accounts, and hopefully that means you’re less likely to touch it for non-emergencies.

You might think it’s hard to put three months’ expenses (or whatever you determine is your ideal emergency fund size) away all at once. And you’re right. For some people it’s much better to start by setting up an automatic savings plan. You can automate your savings by setting up a standing arrangement to transfer a small amount of money from your regular chequing account to your TFSA on the days you get paid. Just make sure that you keep your contribution limit in mind and are careful not to exceed it. Once you reach your ideal emergency fund account size, you can look at continuing to put money away for long term savings. By then, the habit of saving part of your income will be second nature.

So if you’re rainy day fund is just socked under your mattress, it’s not going to grow. Consider putting it in a Tax Free Savings Account instead.

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