Efforts to contain the spread of the coronavirus across Canada have had a tremendous and sudden impact on employment. Many Canadians have lost their jobs, while others are seeing their hours cut back, or are preparing for the possibility of lost work.
If you’ve found yourself in a financial emergency, you need to know your options to fund your living expenses while minimizing the cost to your long-term financial goals. In this article, we’ll weigh the pros and cons of drawing money from various accounts and sources, so you can make the best choice.
First line of defence
Before dipping into debt or your long-term savings, you’ll want to tap into the following:
|Pros||That’s what it’s there for.|
|Cons||Not everyone has one; and once you’ve spent it, it’s gone.|
If you have an emergency fund, now’s the time to use it – and worry about rebuilding it later.
Unfortunately, not everyone is going to have enough cash on hand to cover their living expenses. If that’s the case for you, you’ll need to consider the other options in this article.
|Pros||As a Canadian taxpayer, various types of support are available to help those in need.|
|Cons||It’s limited, and you have to qualify.|
The government has introduced sweeping new support for Canadians who are struggling financially. If you can’t work or are experiencing reduced income because of the pandemic, you likely qualify for a $2,000 monthly credit for up to four months. After that time, you may still be eligible for Employment Insurance (EI) and can apply now to avoid any delays. There are additional benefits available to parents, low income families, and employees who have had their hours cut.
You should also look into the support available in your province as there may be additional benefits available to support lost income, and covering expenses like housing and hydro.
Remember, as a taxpayer, you pay to ensure that these services are there when needed. Now’s the time to use them.
Shave down your expenses
As soon as you recognize that you’re headed for a financial emergency, you’ll also want to pause any unnecessary expenses coming out of your accounts.
Look at your monthly bills and see where you can cut back. For example, cancel unnecessary subscription services, delay big purchases, and budget your grocery bills. Given current circumstances, don’t overlook things you may not be using now, such as transit passes and gym memberships. If you make regular contributions into long-term savings or investments, you’ll probably want to put those on pause, too.
You may also be able to delay some of your critical expenses. Look at your regular bills and do some research to find out whether your service provider is offering any relief. For example, if you have a mortgage, your bank should allow you to defer payments for up to six months. Depending on where you live, your hydro provider may also be offering payment extensions.
Borrowing vs. cashing out investments
If you still need additional funds, you’ll want to draw from the funds that will have the least impact on your long-term financial goals.
To help you make the right decision, consider these pros and cons:
Borrowing: Line of credit
|Pros||You may be able to avoid cashing out your investments at a loss.|
|Cons||You’ll need to pay interest; and you may not be eligible to secure a new line of credit if you’re unemployed.|
If you have a line of credit set up for emergencies, it’s worth considering whether to use it now. Interest rates are low, so the rate you pay on a line of credit may mean you’re taking less of a loss than you would if you cashed out your long-term investments at their current value.
Of course, you can’t know for sure when the trade-off tips in favour of cashing out. The bigger the gap between your interest rate and your investment losses, the more likely using credit is the better option.
A big word of caution on debt: you should avoid using credit card debt or payday loans. That high interest can snowball, piling up more and more each month, and becomes extremely difficult to pay off. That can have lasting impact on your personal finances and should be your absolute last resort.
Generally, an interest rate under 10% is reasonable for an unsecured line of credit, while you can expect a rate closer to prime plus 1% for a secured line of credit, but you’ll need to put up an asset, such as your house, as collateral. Learn more about lines of credit.
Cashing out investments
The markets have taken a big hit since mid-February, and if you hold investments, you’re likely seeing that loss reflected in your portfolio. While it’s uncertain how long this downturn will last, historically, markets have always recovered and posted gains once again.
That’s why it’s best to avoid cashing out during a downturn. When you cash out, you lock in your losses and miss out on the possibility of recovery. And right now, that loss may ultimately outweigh the cost of paying interest on a line of credit.
If you do need to draw from your investments, you’ll want to pick the right account:
TFSA or Non-registered investments
|Pros||That money is yours and there are no restrictions when you withdraw it.|
|Cons||The market is low, so you may be cashing out at a loss.|
When you withdraw from a TFSA, you won’t suffer any tax consequences and while you might temporarily sacrifice contribution room this year, you’ll gain that room back at the start of next year.
Similarly, a non-registered account has no restrictions on withdrawals, but you may trigger capital gains. On the other hand, given the downturn, you may be withdrawing those funds at a loss, which you’d be able to use to offset taxable gains in future years.
|Pros||That money is yours.|
|Cons||You’ll cash out while the market is low, forfeit contribution room permanently, and pay tax penalties.|
You’ve heard it before: generally, dipping into your RRSP before retirement isn’t ideal. The first reason is that you’ll never gain that contribution room back. The second is that you’ll be taxed on withdrawals.
The silver lining? When you’re not earning an income, the tax implications may not be as consequential because you may end up in a lower tax bracket for the year.
If you do decide to withdraw from this account, proceed with caution. When you withdraw money, you’ll automatically pay a withholding tax based on the amount being withdrawn. So, if you withdraw $30,000 from the account, it will be taxed at 30% and only $21,000 of that will end up in your bank account.
That withholding tax doesn’t necessarily reflect your annual tax rate, so come tax time next year you may end up getting money back, or you may end up with a balance owing, particularly if you end up back at work within a few months.
Remember that reaching your financial goals is a marathon, not a race. Now that you know your options, choose the ones that will have the least downside on your financial future. That’s how you’ll overcome this hurdle.