Consider your needs before taking cash from investments. Are you having a short-term financial dilemma, making changes to your lifestyle or starting to fund your retirement? To preserve your wealth you should think about market timing, tax consequences and paying the least amount of taxes possible.
Your assets usually fall within three categories.
1. Tax Exempt Assets
You may be able to tap into the equity that has built up in your home for short-term funds via a HELOC (Home Equity Secured Line of Credit) through your bank. The loan will have to be paid in full when the house is sold, reducing the amount of sales proceeds.
A Reverse Mortgage or Home Income Plan allows you to receive up to 40% of the value of your home. You have the option of receiving a lump sum or ongoing advances, or a combination of the two depending on your needs. There is an age qualification of 60+ years. Money received is not added to taxable income so it doesn’t affect benefits. No payments are required as long as you live in the house and the full amount becomes due when the home is sold.
Many people opt to downsize by selling the family home once the children are gone and purchasing a smaller residence. The difference between the sales proceeds and the purchase price of the new home can provide immediate funds or be invested for future income.
Life Insurance Policies:
You can obtain cash from investments such as permanent or “whole life” insurance. These policies include a savings component or cash value that can be made available or used as collateral on a loan.
Tax-Free Savings Account:
The earnings inside a Tax Free Savings Account are tax-exempt. A good feature is that you can replace any amount that is withdrawn.
2. Tax Pre-Paid Assets
These investments will have been made with “after tax” money (as above) but, depending on the asset, your tax bracket and changes in the market you must be careful when selling to get cash from investments like this in order to best realize profits. The increase in value will accrue on a tax-deferred basis until they are disposed of but when sold 50% of the gain will be taxable. Losses, however, are only deductible against other capital gains, but can be carried over.
3. Tax-Deferred Accounts
An RRSP is a registered account for which a tax deduction was received when the capital is invested. The purpose is to fund a retirement lifestyle, but can be used for periods of unemployment or maternity leave when other actively earned income sources diminish or disappear. Because earnings are sheltered within the plan it is often best to continue the tax deferral as long as possible. The withdrawal of funds from an RRSP is fully taxable so tax efficient strategies should take into account marginal tax rates during your lifetime and at death.
You can tap into your RRSP on a tax-free basis if you want to fund the purchase of a new home or are returning to post-secondary school to finance education under the Home Buyers’ Plan or Lifelong Learning Plan subject to repayment terms.
Some people dutifully contribute to their RRSP each year for the tax deduction without any thought to the eventual withdrawals assuming their income will be less at retirement age. At age 71 your RRSP must be converted to a RRIF and minimum withdrawals must be made. If you receive benefits from a defined contribution plan or defined benefit plan (particularly from the public sector) as well as CPP you may end up in a higher tax bracket and in the “claw back” zone with OAS payments substantially reduced or even eliminated, as well as paying more in taxes. Be sure to make the calculations.
Cash From Investments: To Recap
When under pressure, many people think about withdrawing money from their RRSP’s first. This may or may not be the best option as it will be taxable and may make the situation worse.
You need to ask yourself the following questions. How much do I need? Lump sum, or ongoing payments? Can I use my equity to secure a loan rather than cashing in? Can I sell personal property (vehicle, jewellery) for quick cash? How can I minimize losses?
If you need a large amount of cash from investments, or life-cycle changes such as divorce, illness, moving to another city for a new job, or retirement requires asset disposition, carefully review which assets are accessible to you within your time frame. You want to preserve your resources as long as possible and minimize your overall tax cost.