Tag: Employment

3 thoughts on establishing your emergency fund

Published version: Linkedin

For a long time, we didn’t have an emergency fund, though we’ve had a line of credit (LOC) for quite a while.

Our household budget was within our means. We were operating fine in our regular spending routine without having to check when payday was coming. There was also a fair amount of reserve that had built up in the separate accounts we’d established for each of the major expenses.

It wasn’t for fear of holding money in no/low-interest cash that might otherwise be making investment income. No, that’s exactly the effect of those individual accounts anyway. Rather, we were confident in the arithmetic, and didn’t think there was a need to have that one account.

It wasn’t until we had to dip into one of those reserves to replace an appliance that our perspective shifted: Large though that reserve had become, it had a defined purpose and calculated amount that would eventually deplete it. Emergencies aren’t like that.

1. The why of an emergency fund

An emergency fund isn’t about being budget-conscious; it’s about potentially being UNconscious, indisposed and/or impecunious at a time when there remains a budget to be serviced. It’s about you and your ability to be the continuing funding source for your household.

It’s also about being able to respond to large, unexpected expenses. Be careful though not to confuse that with the major expense reserves mentioned above. Years will pass before those needs may arise, but while the exact timing may be unexpected, those remain inevitable.

At the other extreme from normal budgeting are unlikely things such as catastrophic property damage, permanent disability or death. Insurance is for those remote-risk/high-peril events. Between those two is where an emergency fund is situated.

2. LOC or emergency fund – What’s your gut feel?

Part of my own early confidence lay in the fact that as the mortgage was being knocked down, we’d set up a substantial line of credit. It was more than sufficient for the 3 months – or even 6 or 12 months – worth of accessible funds variously suggested to bridge until things would be expected to normalize after an emergency might hit.

But over time I became more familiar with my own emotional relationship with money. Ever since I had a mortgage … I didn’t want one anymore. Though we lived contently and made appropriate allocations to retirement and children’s education savings, the extra dollars were put toward trimming that large liability. That was the mindset and routine while in the midst of stable finance and balanced emotion.

So, how might I feel in a future time of monetary and mental stress, being compelled to dive deeper into debt? Not good in all likelihood. In fact, that prospect could easily exacerbate the impact of any emergency that may in fact arise, and extend out the recovery time. For us, that was when the formal emergency fund took shape, while maintaining the line of credit as the next line of defence.

That’s our family, not necessarily yours. Still, you would do your future-self a great favour by taking the time while things are rosy to contemplate how you will feel when things are not.

3. Deciding your __ months of money?

Assuming you’re committed to the purpose, the first action question to address is how much will you accumulate in that fund? The commonly suggested proxy is, as mentioned above, a certain number of months’ worth of accessible funds. But how many for you: 3, 6, 12, more?

As the timing and extent of an emergency is unknown, there is no formula to provide you with a definitive number. A practical approach is to focus on the most likely of those unlikely events: an employment gap, whether of your own choice or initiated by your employer. Knowing yourself and the industry where you work, how long do you think it would take to get re-situated? Other factors will come into play, like severance pay and employment insurance, but start here as a rough target.

Second, be clear about what this number of months means. In theory it is lost income, but more importantly in an emergency situation, it is the amount of spending that has to be replaced. The two are connected, but the latter continues even in the absence of the former.

Fortunately, unless you’ve been living excessively, your spending will be less than your earnings. Look back at your bank and credit statements over the last year. Take out the truly extraordinary things, and deduct items you can suspend or defer, at least in the short term. This is the monthly average to multiply by your chosen number of months to give you a target.

Third, how much will you regularly deposit into your emergency fund? By “regularly”, I mean weekly or in alignment with your pay cycle, which brings us back to your budgeting. As remote as an emergency may be, you need to assign a percentage or dollar amount that you can commit to, even if that’s a small figure.

Here then is another gut check: Divide your accumulation target by your weekly deposit commitment to tell you how long it will take to get there. If you’re feeling a knot forming in your abdomen, you may want to bump your commitment. Balance that against the discomfort of the current budgetary sacrifice to arrive at a manageable medium.

With a line of credit at your back along the way, you now have a process, timeline and dollar target to get your own emergency fund in place.

Work interrupted – Severance planning options to help you through the emotional shock

Job loss is a risk we all face. Ask the unfortunate people in the oil patch and at General Motors who are experiencing that first-hand right now.

While you may not be able to completely insulate against it happening, you can prepare yourself with financial habits and tax knowledge to weather through it if it does, and emerge sooner and as intact as possible.

Having a bridge fund

As a type of emergency fund, this bridges the household until the primary or sole breadwinner can get back into financial production. Ideally you’d have this in place well beforehand, but even if you don’t, it’s a habit and mindset that will serve you well if you’re beginning to get nervous about your workplace.

Generally, a three-to-six-month cushion is suggested. While this may serve the purpose, make sure it truly reflects your personal job outlook and spending habits. Without dwelling on it too much, ask yourself on an annual basis what your prospects would be if you had to look for work. And on the spending side, understand what goes toward necessaries, discretionary purchases, and luxuries respectively, and how you will place the latter two on hiatus when required.

Job loss in the moment

It’s an emotional shock, but you need to maintain a clear head in a compressed timeline. The decisions you make will have both immediate and long-term effects. Within that, tax is sometimes simply part of calculating what you have no control over, and in other cases it is a critical contributor to those decisions.

Nature of a payout

Without getting into the minutia of how each is calculated, your employer may owe you one or more of the following, all of which are subject to income tax:

  • Severance pay based on length of your employment, when you are let go without any fault on your part
  • Termination pay that is in lieu of providing advance notice of the last day of employment
  • Vacation pay for earned but unused vacation entitlement
  • Lump sum for accrued benefits (e.g., banked sick days) that may be owed to you on departure

Withholding for income tax, Canada Pension Plan, and Employment Insurance will apply if severance pay is in the form of salary continuance. However, if it is paid as a lump sum, only the tax is deducted. As well, if your employer agrees to defer payment over two or more years, that could ease the tax cost if you are in a lower bracket on each receipt.

Benefit continuation and replacement

Losing health and dental insurance can be an extra disruption, especially if you or your family have upcoming appointments. Ask if coverage could be extended for a time to relieve some of the burden.

For life insurance, employers usually allow you to buy replacement coverage without medical underwriting from the current benefits company. That’s especially important if you’re no longer insurable, but otherwise you may be able to reduce cost by shopping the market.

Retirement funds

Transfer to RRSP: When a large payment comes, you can direct some of that amount to your RRSP if you have room. This will protect against income tax, but be sure that you still keep enough cash on-hand to carry you through your expected unemployment time.

Registered pension plan (RPP): Defined contribution plans can generally be transferred to a locked-in RRSP without any tax issues. Defined benefit plans are more complicated, with possibilities ranging from remaining in the plan, beginning the pension immediately, transferring to the plan of a new employer, or commuting into a locked-in RRSP. Your pension administrator will provide you with a package to review, so get out your reading glasses and fine-tooth comb.

Retiring allowance: Extra one-time RRSP room is available on severance pay to a longstanding employee. It is $2,000 for every year you’ve been with the same or related employer before 1996, plus $1,500 for each year before 1989 for which employer contributions to an RPP or deferred profit sharing plan (DPSP) have not vested. Contributions must be to your own RRSP (i.e., not to a spouse), and the room cannot be carried forward.

Recovery to employment

On top of managing your spending, it’s important to keep your debt under control. At a minimum, make the minimum payments to keep your credit in good standing, bearing in mind that potential future employers will likely do a credit check before hiring.

If you are feeling overwhelmed, consult your financial advisor, a credit counselling service, or an insolvency trustee. They can advise on negotiating with creditors, and discuss whether debt consolidation may be appropriate.

Finally, when you do get resituated, understand and keep an eye on any probationary period you may be under. You should continue to operate with your streamlined spending rules until that period has passed, but in time things will normalize to a new routine, with your future back on track.

Minister of Revenue confirms the CRA is not going after retail employee discounts

At issue

In the house where I grew up, we bought almost all of our clothing, housewares and other durable goods from one retailer. That’s because it was the company where my dad worked, and part of the employment deal was a discount on purchases.

That’s a common practice for retail employees and restaurant workers, and one that garnered some front page media attention recently. It’s not because of any public uproar as if it was some kind of scandalous abuse. On the contrary, it was prompted by what appeared to be a reversal of the Canada Revenue Agency’s longstanding practice of acknowledging these as non-taxable items.

Is the CRA really intending to begin requiring employers to track the savings each employee receives, and report that as a taxable benefit each year?

Income Tax Act (ITA) Canada

Per paragraph. 6 (1)(a), income from employment includes “benefits of any kind whatever received or enjoyed by the taxpayer …in the course of, or by virtue of the taxpayer’s office or employment”. Some exceptions are allowed in the following subparagraphs, with no mention of discounts.

Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment

The CRA has an ongoing multi-year project migrating and consolidating its tax practice guidance from a variety of older formats into the online Folio format. This particular Folio was published in October 2016, but the story hit the headlines in October, 2017.

The Folio states that a discount is generally to be included as an employee benefit under para. 6(1)(a). With the exception of discounts made available to the general public, “the value of the benefit is equal to the fair market value of the merchandise purchased, less the amount paid by the employee.” Responsibility is placed on the employer to “determine the value of the benefit to include in an employee’s income.”

CRA letters 2017-0726641M4 & 2017-0729161M4 – Taxability of employee discounts

An immediate firestorm erupted for the Minister of Revenue Diane Lebouthillier, and within a day she clarified that this was the action of CRA bureaucrats, not the government’s policy intention. One day later, Folio S2-F3-C2 had been taken down from the CRA website, replaced by as a statement that it was “currently under review.”

We now have written affirmation that employee discounts are not on the CRA’s radar. Two letters were published in the last couple of months, from the Minister of Revenue herself. The letters are almost verbatim one another, with one providing a bit of additional reassurance to restaurant employees. The Minister states that the “longstanding administrative policy that employee discounts on merchandise are generally not taxed … is still in place and is explained in Guide T4130.”

T4130 Employers’ Guide – Taxable Benefits and Allowances

This Guide advises an employer that if it sells “merchandise to your employee at a discount, the benefit he or she gets from this is not usually considered a taxable benefit.” If the discount is below the employer’s cost, there would be a taxable benefit for the difference between fair market value and the price paid.

Practice points
  1. Generally, benefits received by an employee from an employer are taxable.
  2. Discounts for an employer’s merchandise and meal discounts for restaurant employees continue to be non-taxable, per the CRA’s longstanding policy.
  3. If a discount is below employer cost then a taxable benefit may still arise.