Why you need both retirement savings and emergency savings

Emergencies happen, but you can do something today to help make an unexpected emergency less stressful—create an emergency savings account. Planning ahead can not only help you be prepared, but it can help keep you from prematurely using your retirement savings.

Saving for emergencies can help you today and in retirement

Saving money is hard to do, but it’s also important. And it’s important to save for the unexpected things that can happen today while you’re also saving for what you can expect to happen in the future—retirement. 

Registered Retirement Savings Plans (RRSPs) can be a big help in saving for retirement, especially group RRSPs offered by your employer. Tax-free savings accounts (TFSAs) and savings accounts, on the other hand, can help you save for the short term—including for emergencies. 

If you don’t have an emergency savings account, it can be tempting to take the money from your retirement savings, but if you run out of money in retirement, you don’t have many options. And when you take money from your RRSP, you’ll have to pay taxes on the withdrawal. It’s better to plan ahead—for both emergencies and retirement. 

What’s an emergency expense?

First, it’s important to understand what is and what’s not an emergency expense. Foreseeable expenses, such as loan payments, new tires, hot water heater repairs, and tax bills—basically anything recurring or somewhat expected—are not emergency expenses. These types of expenses are reasonably predictable and should be included in your regular budget. 

True emergency expenses are for things that are unexpected, maybe even unlikely, but not impossible. Some common financial emergencies include:

  • Major household repairs
  • Car expenses
  • Medical emergencies
  • Job loss
  • Unexpected life change

In an ideal world, you’ll never need to tap into your emergency fund, but because we don’t always live in an ideal world, that extra cash can come in handy. 

If you don’t have the cash in an emergency fund, you might need to put the expense on credit cards or take a loan. Then in order to have the money to pay it back, it can be tempting to stop saving in your group savings plan, which can harm your long-term financial security in retirement.

How to prepare for financial emergencies

1 Set an emergency savings goal 

To do this, start by adding up potential emergency expenses. We suggested a few listed common emergency expenses earlier, but what other surprises might you be able to anticipate, and how much would they cost? In order to come up with your emergency savings goal, think about things such as:

  • Checking your insurance policies: What are your deductible amounts? In other words, how much would you have to come up with before insurance would kick in and pay the rest?
  • Asking your car dealer about the cost of larger repairs
  • Investigating the replacement cost of major appliances
  • Tallying your everyday living expenses

Don’t assume that emergencies can’t happen at the same time—plan to be able to cover a few with your emergency fund. The conventional wisdom is that, generally, you should try to have between three and six months’ of expenses in an emergency fund. 

2 Calculate your emergency savings gap 

Once you've totaled up your potential emergency expenses, look at how much you’ve saved for emergencies. The difference between them is your emergency savings gap. 

Then you can decide how much you can afford to save from each paycheque into your emergency fund to close gap. 

3 Make saving automatic

Consider setting up a separate account with recurring transfers from your primary chequing or savings account. By making it distinct from other savings, you help reduce the temptation to withdraw from it. 

Plan to save for retirement and emergencies 

Although the nature, timing, and scale of the emergency might be unpredictable, actually needing emergency funds someday is pretty predictable. The need for emergency money doesn’t have to hurt your current financial situation or the quality of your retirement if you’re prepared.  

Get your finances ready by:

1 Calculating your emergency savings goal

2 Determining how much you need to meet it

3 Establishing an account funded with automatic transfers

Then leave it alone until the unpredictable happens—and thank yourself for being ready. 

The commentary in this publication is for general information only and should not be considered legal, financial, or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.