Ever have a conversation with someone and have to use every ounce of energy not to speak your mind?
I was having a candid money chat with a (have all the answers) friend of mine about having some savings on hand in case of the worst happening.
He looked at me with a puzzled face and replied “why would I need savings when I have money in my RRSPs (401k for US residents) for scenarios like that?” Rather than going off on a tangent on deaf ears, I’ll vent to my keyboard instead. Sorry that you’re going to take the brunt of it.
Here are the reasons why your RRSP/Retirement Account is NOT an emergency fund:
- Super High Taxes. RRSP withdrawals are taxed at your full marginal rate for that year. Hypothetically speaking, say that $5,000 is needed for an emergency, and you’re in the 40% tax bracket. Providing that you don’t jump to a higher bracket because of the new income, you’ll only receive $3,000 after taxes. Granted that only 10% is taken immediately upon withdrawal (for <=$5,000), but the rest will be tax owing at the end of the tax year. The exception where taxes would matter less is if it was a low income year.
- Contribution room is lost forever. RRSP’s allow for 18% of your previous years income as contribution room which can be carried forward if not used. Once money is withdrawn the contribution room, and potential tax free growth from it, is lost forever.
- Risk of Selling Low. If the markets are in the down turn at the time and you need to withdraw from your RRSP, guess what, you materialized your paper losses.
- The Extra costs. If you own stock, you’ll have to pay commissions to liquidate. If you own mutual funds with deferred sales charges, you’ll have a hefty premium to pay to sell early in the term.
Why not save a few dollars in a high interest rate savings account or even have a HELOC/LOC ready to go for an emergency fund?
Photo credit: Paul Keleher