How to deal with life’s UPsets by creating a cash cushion

Gas prices, electrical costs and heating bills are all up. UPsets like this can cripple your cash flow, so how do you save to prepare

Things are looking up, these days.

Gas prices — up. Electrical costs — up. Heating bills — up.

UPsets like this can cripple your cash flow and figuring out how to cope with them can really get a person down. So, here are some practical ways to find the extra money you need to cushion those unavoidable financial UPsets you face every day.

What not to do. If you find yourself a bit short at bill-paying time, do not fund the shortfall by making a withdrawal from your RRSP or get a cash advance on a credit card.

Here’s why:

• You’ll pay income tax on your RRSP withdrawals – meaning that if you take out $5,000 and are in the 40-per-cent tax bracket, you’ll add $2,000 to your tax bill. You’ll also diminish the potential tax-deferred growth that the $5,000 would have contributed to your retirement lifestyle. If your retirement is 30 years away, that $5,000 withdrawal will cost you $45,313 in tax-deferred growth (assuming eight-per-cent compound annual growth).

• Use your credit card to get that $5,000 and you’ll probably pay interest at 18 per cent or more. That adds up to $978 in yearly interest and if you don’t pay the balance all year and you’re in the 40-per-cent tax bracket, you’ll need to earn $1,630 just to pay the interest.

What to do instead:

• Consider consolidating your debt through a lower-rate loan from a financial institution. Use the loan money to pay your debts — targeting credit cards and other high-cost non-deductible debt first.

• Obtain a line of credit based on the equity in your home or other assets, usually available at a very favourable interest rate.

• Arrange a revolving line of credit to cover overdrafts on your bill-paying chequing account.

You’re coping financially right now but … What happens if you’re hit by a serious illness or a huge house or vehicle repair bill? Once again, DO NOT tap into your RRSP, and avoid dipping into your savings or borrowing by:

• Setting up an emergency cash reserve, typically equal to three months’ income, or if your job is iffy or seasonal, make that five or six months’ net income.

• Turning your emergency fund into an investment in a Money Market mutual fund, Guaranteed Investment Certificate (GIC), that are Tax-Free Savings Account (TFSA) eligible or government savings bond that will protect your capital, deliver a decent interest rate and let you withdraw your money quickly with little or no cost as needed.

Price and rate UPsets are a fact of life but you can cushion the effects when you’re financially prepared. Keep your spirits up and your costs down by talking to your financial adviser.

J. Kevin Dobbelsteyn is a certified financial planner with Investors Group Financial Services Inc. His column appears every Wednesday.

 

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