In the sci-fi classic Ender's Game, gifted children play simulated battle games with aliens at the edge of the universe, until (spoiler alert) the title character realizes during an especially intense sequence that he's in the midst of the real thing, and everything to that point has just been practice.

When you last contemplated your emergency fund, a global pandemic would have been well at the perimeter of possibilities. And yet, here we are.

Regular budgeting vs. emergency savings

If you have an emergency fund in place, you may now be asking: How do I use it? And if you don't have one – but are fortunate enough to still be in regular earning mode – you should also be thinking about how and when you will use this fund as you begin saving.

Regular budgeting addresses recurring expenses, plus reserves for expected larger expenses. Insurance is for the extreme where there are remote-risk/high-peril events. An emergency fund lies between.

This fund allows you to sustain your household in a time of crisis – whether that's an unexpected injury, job loss or a global pandemic – while expenses continue to pile up.

How and when you should use the emergency fund is a function of how you define "emergency." Commit yourself to the above definition when you begin saving so it's preserved for truly pressing needs – like now – and not depleted on emotional wants.

Guidance for using your emergency fund

Food and safety

The immediate non-negotiable needs are food and safety. You can cut down on these expenses by shopping brand-consciously, reducing cost-per-unit by buying in (reasonable) volume, and being vigilant about portioning and waste.

Shelter

Shelter costs like rent/mortgage and utilities are next. Federal government income supports should help indirectly, and housing specific relief is available from governments, lenders and landlords or a combination. Whatever form and amount this takes, it's crucial to understand the implications of these supports: interest and penalties on short/skipped payments will compound the emotional and financial stress the very next month, and further delay your financial recovery.

Reasonable pleasures

Dispensing with all discretionary purchases may not be practical as you hunker down for the coming days and weeks, but try to be selective about the pleasures you choose.

Luxuries

Suspend luxuries and harbour no regrets. Keep your focus on the present, comforted that your conscientious actions today will improve your prospects tomorrow.

Log where your money is coming from and where it's going, so you can manage within your changing means. That's a good habit in good times, and critical in a crisis. Many of us have a bit more time to do that these days, which could be a catalyst for you to form the habit.

Building a fund for future crises

The emergency fund's purpose, now or after the COVID-19 crisis, is to have money accessible for a specific number of months. But how many? You should start by planning for the most likely emergency: an employment gap.

1. Based on your industry and geographic location, how long do you think it would take to get re-situated? An estimate provides a goal for the number of months of funding.
2. While losing income is painful, what matters most in an emergency is spending. Review your bank and credit statements from the last year, taking out anything truly extraordinary and deducting items you may be able to defer for a few months. Divide the total by 12 for a monthly average, and multiply by the chosen number of months. This is your lower limit: add back those deferred items to obtain your upper limit.
3. Decide on your regular deposit to the fund, ideally aligned with your pay cycle. Assign either a percentage or dollar amount you can commit to, even if it's a small figure.
4. Now, the gut check: divide the emergency fund target by the weekly deposit commitment. This will show how long it will take for you to get there. If you feel a knot forming in your stomach, you may want to bump that commitment. Balance that unease against the discomfort from the current budgetary sacrifice in order to arrive at a manageable medium.

Supporting role for a line of credit

As a kicker, an oft-suggested alternative to an emergency fund is a line of credit at the ready with your bank or credit union. But for some people, taking on debt at a time of financial stress may be an uncomfortable proposition.

Even so, establishing a line of credit can be an effective complement to an emergency fund, knowing that it will be there to fill the gap if an emergency hits before the fund reaches its target.

Choosing the right account

Your RRSP is not an appropriate choice as an emergency fund. With withholding tax as much as 30%, you will have to take a higher gross amount to net to what you need. Withdrawing from an RRSP for an emergency also puts retirement at risk. Keep these two needs separated.

On the other hand, the TFSA is well suited for emergency needs. With no tax to deplete withdrawals, budgeting is much more transparent. Withdrawals are also entitled to the usual re-contribution credit the following January, which can be both the motivation and target for replenishment once the emergency passes.

This article was written for Credential Securities and Credential Asset Management by:

Doug Carroll
Tax Estate and Financial Planning Advocate
BBA, JD LLM(Tax), CFP, TEP

Mutual funds and other securities are offered through Credential Securities, a division of Credential Qtrade Securities Inc (“CQSI”). Mutual funds are offered through Credential Asset Management Inc (“CAM”).