I help people who are in financial difficulty know their options and how to best move forward. The people who come to me for help have usually faced some kind of unforeseen circumstance that has negatively impacted their finances and pushed them into the deep end. They then tread water for as long as they can, trying for months or even years to pay down all their debts.
Sometimes, in an effort to do all they can for their creditors, people liquidate their RRSPs, the cash surrender value of their life insurance policies and even the RESPs they had started for their kids. The emotional trauma of being pursued by creditors is a daunting experience and liquidating assets is done out of sheer desperation to get some relief.
When all debts are paid out by RRSPs, you have:
- made good your commitment to pay your creditors; and,
- avoided taking more drastic measures such as bankruptcy.
However, if you’re considering this option for yourself, there are three big costs to to be aware of:
1. Your investment has been eliminated
Sure this sounds obvious, but think back to the reason you decided to purchase these investments initially. RRSPs provide you with income to live on when you are older, and without RRSPs you will be required to live on Old Age Security and the Canada Pension Plan, which do not provide much in the way of monthly cash flow. I have seen elderly people try to live on $1,500 per month who end up utilizing credit cards to fill in the gaps between their income and their base costs, and eventually file for bankruptcy down the line because the cost of living is just too much. Without life insurance, you may be leaving your family with the burden of dealing with your finances when you pass away and getting additional insurance can become cost prohibitive as you get older.
2. You could owe more income tax
At the time the RRSP is collapsed, the financial institution is required to remit 10% of the RRSP to the government for income taxes. Unfortunately, this means it is likely that not enough income taxes were deducted and there will be another bill to pay come tax season.
3. It eliminates the benefits of compound interest on your savings
Even if you re-purchase new investments in the future, you have compromised the available earning potential with the original investment. In order to earn the same amount, you will now have to spend considerably more because you have lost the benefit of having that investment compound and grow over time.
Now I am not suggesting you shouldn't do all you can do to resolve your financial difficulty before filing for bankruptcy or a consumer proposal. But, as with anything, it is important to get good information about your options before proceeding. Knowing the benefits and drawbacks of your options allows you to make an informed logical decision instead of a rushed emotional decision.
Under the Civil Enforcement Act of Alberta, most RRSPs, life insurance policies and RESPs are exempt from seizure. In layman’s terms this means your creditors cannot take these assets away from you in an attempt to collect the outstanding debt. In a bankruptcy or consumer proposal, you would be able to retain these assets.
If you are considering selling your assets, there are only two outcomes to this scenario: all debts are paid out with the proceeds of the investments; or only a partial payment on the debts is made.
Too often the second scenario takes place, where only a portion of the debt is paid down with the proceeds from the sale of the assets. The danger is that, if the balance remaining on the debts is not manageable, then the assets were sold without creating any real change in your circumstances. If you are selling assets, work the numbers first to ensure the balance remaining will be paid out in a short period of time.
If you have reliable income and can make regular payments, filing a consumer proposal and keeping your assets is a great alternative. If you do not have a consistent income and cannot make regular payments into a proposal, you might still look at selling your assets. But instead of just reducing your debts, you could propose to your creditors that you will redeem your investment and they, in return, will forgive ALL the debt. This way, if you do have to lose that future retirement income, you have at least traded it for a considerably larger debt repayment and avoided filing for bankruptcy. Consumer proposals are also nice because, if your creditors vote no, the proposal may have failed but it ends right there — you are not automatically bankrupt, and at least you know you made every effort to avoid bankruptcy and maximize return for your creditors.
So if you are struggling and thinking of liquidating your assets, come talk with us. Maybe liquidating your assets is the best idea, but maybe there are better options out there too. Let's talk. Your future 65 year-old self will thank you for it.
If you want to meet for coffee or have a chat over the phone we can discuss what might be best for you.
Rebecca Frederick, CIRP, Trustee in Bankruptcy