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You’ve set aside some extra money and want to put it to best use? Here's a few tips.
Firstly, congratulations! You’ve set aside some extra money, and you’ve asked that age-old question – how do I put my spare cash to best use?
And, the answer is – it depends!
‘It depends’ on many things, including your:
Anything else? After all, we can’t plan for the unknown, or can we? And, the answer is …. yes, we can.
What’s commonly known as an ‘emergency fund’ is an amount of money that we set aside in a ‘safe’ investment which can be ‘readily accessed’ at any time.
‘Safe’ means that the funds are held in an investment product where there’s a very low risk of loss and with a financial institution where there’s low chance of your money not being there when you need it.
An Insurance GIC (Guaranteed Income Certificate) is an investment product with a low risk of loss. It can only be purchased from an insurance company, which makes them eligible for protection from Assuris, a not-for-profit organization that protects Canadian policyholders if their life insurance company fails. Please refer to assuris.ca for further information.
‘Readily accessed’ means that I can get my hands on it on the day that I need it or within a few days. However, the idea of it being ‘readily accessible’ doesn’t provide you with a license to access it for other reasons, annual vacation, for example. Otherwise, it’s not truly an ‘emergency fund’.
Since the onset of the COVID-19 pandemic, the importance of having an ‘emergency fund’ has become more significant.
Now that we are getting back to that new normal, how best to proceed? The ‘emergency fund’ is a good first choice for your extra money.
How much should I have in my ‘emergency fund’? Common thinking is three to six months of pay.
Seems like a lot? So, how do I get there? Little by little – start, now, by setting aside an amount from your pay every pay and plan to get there in two to three years. (Yes, it’s going to hurt a bit, but it’s worth it!)
Let’s have a look at a hypothetical case scenario:
Armand is 30 years old, living in St. John’s, Newfoundland. He lost his job during the pandemic so he had to move back in with his parents. Now, he has a new job. And although he’s grateful to his parents for helping out, he prefers his independence as he had been living on his own since he was 20.
Armand’s decided that he wants to be more responsible about his financial future. After all, his parents are getting older and will soon be retiring. He doesn’t want to be one of ‘those kids’ that keeps going back to their parents for help, since they’ll soon be living on pensions and their life’s savings.
Armand’s new salary is $40,000 per year. His monthly take home pay is about $2,600, after all the deductions. Three month’s pay would be $7,800 – seems like a lot? It is a lot – 25% of his take home pay! How’s he going to get there?
If Armand ‘pays himself first’ and sets aside 10% of his net pay, he will achieve his ‘emergency fund’ goal in 2 ½ years. Ideally, he should aim to save 10% of his gross pay and then he would get to his goal, sooner. Perhaps this is something he can work towards once he gets started.
This is not only a smart decision, it establishes a pattern of saving, which he can continue to benefit from throughout his life.
And, it may even be easier than he thinks. He may be able to take advantage of an employer savings program or set up an automatic transfer to a savings account – perhaps with a financial institution, other than where he does his day-to-day banking, making access to his savings a little ‘out of reach’. The idea being if you don’t see it, you don’t miss it.
Need help to plan a budget? Use this calculator from the Financial Consumer Agency of Canada.
The debt pitfall
Debt is the next item to tackle and it may take priority over the ‘emergency fund’. Yet, again, it depends! In this case, it depends on the type of debt that you have and the associated costs.
There’s good debt and there’s bad debt. ‘Good debt’ is debt that may fall into one of the below categories: This is debt that is used to:
However, it is only ‘good debt’ if you can meet your commitment to pay the interest and/or main payments on a regular basis and when due, while meeting all other financial commitments, continuously.
‘Bad debt’ is commonly considered to be debt that may fall into one of the below categories:
The Government of Canada defines payday loans as ‘a short-term loan with high fees that make it very expensive…. Payday loans are very expensive compared to other ways of borrowing money’.1 It warns about the use of payday loans to pay for ‘ongoing costs such as rent, groceries or utility bills’ and states that ‘the cost may be equivalent to an interest rate of 500-600%’.1
For more information about payday loans refer to Financial Consumer Agency, Government of Canada
Consider first paying off your payday loans. Then, you may want to get a complete understanding of the nature and cost of these loans, as well as try to understand other potential options before you access any such forms of borrowing in the future.
Credit cards and charge cards are frequently used for consumable items with, arguably, no lasting value. Such cards, also, charge high interest rates. For many credit cards, annual fees may apply, and the purchase interest rate is often 19.99%2. This form of debt is very costly. So if you have an unpaid debt on a credit card or charge card, consider using your money to pay down and pay off the balance in full as soon as possible. Then, commit to only using your credit card for amounts that you know you can pay in full each month by the balance due date.
To understand the cost and time period over which you can pay off your credit card debt, see the Credit Card Payment Calculator3, Financial Consumer Agency of Canada.
A line of credit should likely also be paid down, even though the rates of interest are generally lower than charged on the above types of debt. Be aware of what has caused this debt. Try to understand the reason(s) for the debt, such as spending on ‘wants’ versus ‘needs’. Cutting back on some of those discretionary purchases will help you towards your goal of being debt free.
Future plans and goals.
Whether you have a shorter term, mid-term or long-term plan or goal, saving is good. And, a disciplined approach to saving money is even better. ‘Pay yourself first’ – aren’t you worth it? – is a personal finance strategy for getting you to that ‘savings’ finish line. Save or invest a certain amount of money ($ or %) from each pay and then pay your monthly and discretionary expenses from the remaining balance. And, as your income rises, save more!
Choosing the right type of investment
When deciding what type of investment and in what type of account to invest the savings, here are considerations:
What type of investment?
Your investment time horizon and appetite for risk are key considerations when thinking about which type of investment instrument to invest. A shorter time horizon (say one to three years) means your investments may potentially be impacted by changes in market conditions that are beyond your control. Individuals should consider investing in products that have a lower risk of decline in value, such as:
What type of account?
Other options for funds to be invested for the near term is often a non-registered account or a tax-free savings account (TFSA). The TFSA would likely be your ‘go to’ option if you have available contribution room. The income earned in a TFSA will likely not be subject to tax, while income earned within a non-registered account will be taxed when received or earned.
Refer to the article A Comparison TFSAs, RRSPs, RESPs and non-registered accounts
While we may think that age and stage of life fall hand-in-hand with each other, we can’t limit ourselves to such stereotypical thinking.
Young adults, today, have the same competing interests for their earned dollars as their parents had; however, the competing interests have gathered heightened attention and, likely, rightly so, because of a few key factors:
Although, young adults, are likely not dreaming of their retirement, it is well known that individuals benefit from saving early, saving often and staying invested.
If an employer’s benefit package includes a DBPP, DCPP or group retirement saving plans (Group RSP) with or without a matching program, participation in these plans should be strongly considered. Join! Not only does this get you saving, it may provide an opportunity to accelerate savings towards retirement (remember your employer may also be contributing), and, such savings can be tapped into when buying a home.
Is buying a home your goal?
The home buyers’ plan4 (HBP) ‘allows you to withdraw from your registered retirement savings plan (RRSP) to buy or build a qualifying home for yourself or for a related person with a disability’.5 Up to $35,0006 can be withdrawn from your RRSP, but keep in mind that there is a requirement under the HBP to repay7 your RRSP.
Refer to article RRSP Home Buyer’s Plan
In addition, the Federal Government announced a new registered savings plan in the 2022 Federal Budget8, the Tax-Free First Home Savings Account (FHSA), to help individuals save for their first home. Up to $40,000 can be saved, subject to an annual $8,000 contribution limit, starting in 20239. And, amounts withdrawn for a qualifying home purchase should not be subject to tax.
Refer to article on 2022 Federal Budget
Is education your goal?
If returning to school is in your future, your time horizon is likely short to medium term and the investing principles outlined above would apply. However, another option may also be available to you if you have been contributing to an RRSP. ‘The Lifelong Learning Plan (LLP) allows you to withdraw up to $10,00010 in a calendar year from your registered retirement savings plans (RRSPs) to finance full-time training or education for you or your spouse or common-law partner’.11 Similar to the HBP, there is a requirement under the LLP to repay your RRSP8.
Refer to article Lifelong learning plan
If saving for your children’s education is top of mind, your money can be contributed to a registered education savings plan (RESP). To open an RESP account, your child must have a social insurance number; easily attained from Service Canada. The maximum amount that can be contributed is $50,000 and, as a minimum, the Federal government will contribute 20% (the Canada education savings grant12) up to $2,500 contributed for each RESP beneficiary in a calendar year, up to a Canada Education Savings Grant lifetime maximum limit of $7,20013 for each beneficiary. Families of modest income may, also, benefit from the Canada Learning Bond when contributing to an RESP for children born in 2004 or later. And, additional incentives are provided by some provinces when contributions are made to an RESP.
Refer to article A Comparison TFSAs, RRSPs, RESPs and non-registered accounts
For the adult who may no longer consider themselves young and either nearing retirement or in retirement, having some extra money, can go a long way towards, paying off debt, event ‘good debt’, because debt in retirement leaves you exposed to potential future interest rate increases. An interest rate increase, when living on a fixed income may leave you making choices to cut back on spending in other areas of your life.
If you have other high-cost debt, think about paying it off first.
If you are debt free, celebrate!
With extra money in hand, you may think about providing some financial help to loved ones, perhaps an adult child. While such a gesture is generous and it would be nice to lend a hand, picture your future self. Make certain that you are not putting yourself in a position where you may not be able to meet your future needs, keeping in mind that we tend to underestimate how long we will live.
If nearing (say three to five years away) or in retirement, you have three options:
A further thought regarding that RRSP contribution, making that contribution today may result in your old age security (OAS) getting clawed back in the future. Consider whether getting that tax deduction, today, might be at the expense of a future benefit (e.g., OAS clawback). Speak with a qualified tax advisor to explore how to best proceed.
What else might you do with extra money in hand? Here are some examples,
For obtaining help in updating a will, refer to article 7 legal documents to have ready at retirement
For a list of organizations that can issue an official donation receipt refer to the Government of Canada.
Cash affords us options. Finding a way to save more money, may be as simple as asking the question is this a ‘need’ or a ‘want’. Speak with an Advisor or a planner to help you put some positive strategies in action.
Important information
Please don't consider this information as tax advice. Please consult a qualified tax specialist as needed.
[1] Financial Consumer Agency, Government of Canada, https://www.canada.ca/en/financial-consumer-agency/services/loans/payday-loans.html#toc0
[2] Financial Consumer Agency of Canada, Government of Canada, Credit Card Comparison Tool, https://itools-ioutils.fcac-acfc.gc.ca/CCCT-OCCC/SearchFilter-eng.aspx
[3] Financial Consumer Agency of Canada, Government of Canada, Credit Card Payment Calculator, https://itools-ioutils.fcac-acfc.gc.ca/CCPC-CPCC/CCPC-CPCC-eng.aspx
[4] Certain conditions must be met in order to be eligible to participate in the HBP
[5] Government of Canada, What is the Home Buyers’ Plan (HBP), https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/what-home-buyers-plan.html
[6] Government of Canada, https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/what-home-buyers-plan/participate-home-buyers-plan.html
[7] Government of Canada, https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/rrsps-related-plans/what-home-buyers-plan/repay-funds-withdrawn-rrsp-s-under-home-buyers-plan.html
[8] Government of Canada, https://www.budget.canada.ca/2022/home-accueil-en.html
[9] Subject to Government of Canada approval.
[10] Maximum of $20,000 each time you participate in the lifelong learning plan.
[11] Government of Canada, Participating in the LLP, https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4112/lifelong-learning-plan.html#Chpt_1
[12] The Canada education savings grant is paid until the year that the child turns 17.
[13] Government of Canada, Registered Education Savings Plans (RESPs), https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4092/registered-education-savings-plans-resps.html#Gov_grants
