Covid 19 – What do you do if your debts are continuing to rise?

Why this message to you today? As we move into the 4th and 5th month of this global pandemic environment, you may have found that your credit card and line of credit debt has continued to rise.  While your expenses may be less, so too may be your income.  How do you best manage this rising debt?

Should you:

  • Continue to add debt to your credit card or line of credit?
  • Should you cash in some of your investments?
  • Should you cash in your RRSP?
  • Should you draw from your TFSA?
  • Should you talk to your bank about a consolidated loan?
  • Should you add that loan to your current mortgage?

These are all possible considerations, but you will want to find a balance between your cash flow needs, taxation and the potential opportunity for your investments to continue to grow in the months ahead.

Consolidating higher interest loans into a longer-term, lower-interest loan or mortgage may be the best approach.  This approach does not attract any tax implications and can help you reduce your payments.  The key is to make sure you don’t continue to create more debt from this point forward.

If you cash in some of your investments there will likely be some tax implications.  If you sell an investment in a taxable investment account, you may need to pay some capital gains tax on this transaction.  The amount of tax owing is calculated as:  the total gain / 2 X your marginal tax rate.  To help reduce the amount of taxable capital gains, you can also sell some investments at a loss so that your taxable losses are used to reduce the amount of taxable capital gains.

If you cash in some RRSP’s, then the entire amount of your withdrawal will be taxable at your marginal tax rate.

You won’t know what your marginal tax rate is until you add up all of your income for 2020.  However, odds are that your marginal tax rate will be between 25% and 45%.  This means that you may need to pay anywhere from 10% to 45% tax on the amount of any withdrawal from your investments.

Therefore, making withdrawals from your investments can attract alot of tax.  It is important to know the implications of this decision before you make it.  Once the decision is made it is difficult, if not impossible, to reverse it.

The exception to this would be a withdrawal from your TFSA.  While our preference is to see you use the TFSA as a longer term emergency reserve account, perhaps this is the type of emergency you have been preparing for.  Any withdrawals from a TFSA is tax-free to you.  If your life returns to normal in the coming years, you can also contribute back to your TFSA the amount of money that you withdrew.  This is not the case with your RRSP.

In many cases a consolidation loan may be preferable.  You may wish to leave your investments where they are so that they can potentially increase in value in the years ahead.

The bottom line:  If you need extra money today it is important to look at the pros and cons of various options so that you are aware of all of your choices and the implications of each.  Making the wrong decision could cost you considerably more in taxes, increased borrowing costs, lost opportunity for investment growth or some combination of all three.

Here is an interesting article that provides some similar thoughts.

Road To Mastery Principle:  It doesn’t matter what you have, it only matters what you keep, after-taxes, fees and inflation.  The Masters plan their affairs proactively, the begin with the end in mind, and are very focused and purposeful in their decision making.

"IMPORTANT DISCLOSURES: The comments above are for information purposes only and do not constitute specific financial advice regarding your specific situation. Please consult a professional financial advisor who is familiar with your personal situation before acting on any information presented above. Every effort has been made to ensure this information is presented responsibly and accurately. However, important details may have been missed or these details may have changed since the publication of this note. All facts and opinions noted above must be reviewed to ensure their accuracy is still relevant based on today’s specific situation, whatever that may be. Nelson Financial Planning Corp is not responsible for any action you take regarding this information."