There are reasons why RSP’s, insurance policies, equity in the home, among other items are exempt from being liquidated in the event of an insolvency. In an effort to keep this blog post at a reasonable length, I won’t go into detail about our highly leveraged financial system. In saying that, suffice it to say, that if the banks want their billions in profit by lending money they don’t have, then we need to make sure that people don’t get cleaned out if a life event prevents them from being able to service their debt load.
By financially restructuring and retaining assets, the individual is then more self-sufficient and a greater ongoing financial contributor to our economy for the long term.
Let’s have a closer look; the example is based on our typical client. A 45 year old with the average unsecured debt of $48,000. The average interest rate is at 18% and minimum monthly payment of $1,440 per month.
What will it truly cost if they withdrew money from their RRSP to pay off $48,000 unsecured debt?
In addition to the $48,000 withdraw, withholding tax needs to be included. This raises the withdraw amount to $60,400.
What would it have looked like if the $60,400 in the RRSP was untouched until retirement at age 65 at a 6% yield?
The RRSP would be worth $193,710.
Pretty good, but that didn’t deal with the debt that is growing at 18%, not 6%.
We have rules and systems in place in Canada which allow people to access relief from the crushing burden of debt, offering them a fresh start in terms of being able to manage their financial affairs. In most cases, if prepared properly by a company that represents the interests of the client and not the creditors, the individual may be able to retain their assets and keep their portfolio intact while also significantly reducing the debt amount and monthly payment.
Now we return to the client and deem their situation insolvent as they do not have the monthly cash flow to survive and pay down the debt. A carefully structured insolvency filing could reduce the debt down to $12,000; $200 a month over 60 months.
If the client then used the extra cash flow they now have of $1,240 to contribute to their RSP until retirement and add to the $60,400 that was protected under the Insolvency Act, then the value of their RSP would be……$772,867 along with zero debt.
That’s a difference of almost $640,000. this may seem to be an extreme example, nevertheless it does flood light on the true cost of liquidating investments to pay off debt. A restructuring of this sort should only be considered when coupled with advice that comes from a highly experienced restructuring specialist that has only the clients best interest in mind.
