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Your emergency cash cushions

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So you know you should set aside a few months worth of expenses in case of emergency. But where should you keep that cash cushion? How do you keep your money from losing value, while keeping it in a place where you can access it quickly in an emergency?

To answer those questions, we need to understand the concept of liquidity—assets that can be turned into cash quickly and easily. For example, you can go to the bank and take money out of your savings account. That’s liquidity. But it would be more complicated and take longer to turn home equity into cash.

Follow these tips to make sure your money is available, or liquid, for those unexpected costs:

  • Consider opening a tax-free savings account (TFSA). These government-registered savings accounts allow you to contribute up to $5,500 annually, and offer tax-free withdrawals Footnote * and investment income. A growing number of employers offer group TFSAs.
  • Avoid making early withdrawals: from your group retirement and savings plan. When you take money out of your group plan before retirement, a portion of that money is withheld and sent to the Canada Revenue Agency (CRA) to help cover the cost of taxes you’ll have to pay on your withdrawal amount. You’ll also have to claim the money you withdraw as income. Depending on your tax bracket, you may have to pay more in taxes than what your financial institution sent to the CRA on your behalf. Early withdrawals also jeopardize your retirement income in the future, because you won’t benefit from compounding growth—a key to increasing your savings that works best over the long term.
Footnote *
* The full amount of withdrawals can be put back into a TFSA, but only in future years. Re-contributing in the same year may result in an over-contribution amount, which would be subject to a penalty tax. And if you have an investment TFSA, you could be charged fees for any withdrawals within the first 30 days of your investment. (SourceOpens a new website in a new window - Opens in a new window )

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Next lesson: The power of a group plan