Putting your rainy day money to better use: Opt for line of credit: More tax efficient, and unless you use it, it costs you not

National Post


When reviewing clients' portfolios in the context of recommending an
appropriate asset mix, it's rare to find a client who doesn't have a sum of
money in a 'rainy day fund.'

This colloquial term is used to describe funds that have been set aside in
either cash or near-cash equivalents that may be drawn upon in the event of that
rainy day.

The philosophy behind a rainy day fund is that there should be an easily
accessible source of money in the event something happens that requires a large,
immediate and unexpected cash outlay, for example, to repair a leaky roof
(perhaps the true source of the term).

The problem with a rainy day fund is that in many situations, it is
unnecessary as well as costly and not tax efficient.

Should you find yourself with an immediate need for cash, generally there are
other sources available.

One of the best sources of short-term funds is a line of credit. This can be
arranged at any time but need not be drawn upon until the funds are actually

A good relationship with your lender should allow you to get a line of credit
at your institution's prime lending rate if the loan is secured by your home.
Interest charges apply only when amounts are drawn from the line of credit: If
you don't use it, it doesn't cost you anything.

The advantage of having a line of credit available is the ability to free up
money that would otherwise be sitting in a rainy day fund. Generally, this money
is invested in low interest-bearing (or even non-interest-bearing) accounts or
short-term money market instruments.

In addition, any interest income earned is taxed each year at your full
marginal tax rate.

The money could be better invested in equities, which have traditionally
produced higher rates of return than fixed-income investments.

Finally, the returns on equities are taxed as capital gains at only 50% of
your marginal tax rate.

The money freed up from the rainy day fund could instead be invested for the
long term to fund your retirement or perhaps a child or grandchild's
post-secondary education.

The lines of credit available today are extremely flexible. They can be drawn
upon by cheque or via your debit card at a bank machine or at various merchants
that accept direct debit payment.

So before setting up your rainy day fund, consider whether there are perhaps
more productive and tax-efficient uses of your money.

GRAPHIC: Personal finance