An interesting financial exercise is to calculate how long your savings would last if you were to lose your job or other main sources of income. Basically, how much of an emergency fund (cash or line of credit) would you need? In this “worst case scenario”, proper planning needs to be in place to be prepared for the worst and/or peace of mind.
So what do we do in the case of losing main sources of income? First, we need to look at household expenses and cut back where possible. Next, we’ll need to evaluate what types of incomes are available with no salary. Following that, existing savings/investments will need to be examined to see what can be liquidated to provide cash flow. As a last resort, new debt or liquidation of retirement savings can be used.
Some assets to consider,
- Employment Insurance – This usually kicks in after about 4 weeks and lasts for about a year. The maximum EI benefit is around $1500/month after taxes/deductions.
- Cash Savings – Some people don’t like to have cash hanging around, but we usually have cash in our accounts as it gives us a sense of safety. As well, it allows us to take advantage of opportunities that require cash as they come up.
- Tax Free Savings Account – The TFSA can be withdrawn from completely tax free and is a tax efficient way to keep your emergency funds.
- Non Registered Investments – We have a leveraged non-registered investment account that produces dividends, but could be liquidated if need be.
- Home Equity Line of Credit – If you have home equity, then a home equity line of credit can provide instant cash at a fair rate. However, the higher the balance grows, the higher the required interest payments will be.
- Retirement Funds – In my opinion, retirement accounts should be the last resort in terms of providing cash flow due to the high taxation along with losing the contribution room forever. However, with the low amount of income that year anyways, it may be an opportunity to withdraw from an RRSP at a lower tax rate.
In our family, both spouses have professional jobs which would qualify us for employment insurance. In addition, we have a healthy savings, non registered portfolios, some borrowing room on our line of credit, and fairly healthy retirement accounts..
If we were to both lose our jobs simultaneously, this is the order that I would use our funds until new work is found.
- Savings Accounts/Cash on Hand: $12,000 (most of our cash was recently used to pay down mortgage)
- Tax Free Savings Account: $0 (not funded yet)
- Non Registered Investments: $60,000 ($45,000 leveraged, $15,000 regular)
- Line of Credit (s): $95,000 available (HELOC and PLC)
- Retirement Funds: $63,000
How long could we pay our expenses without going into debt or touching our retirement funds? With no salary (assume no online income or severance), the only source of income left is via dividends in my leveraged investment account and employment insurance (EI). As of right now, dividends provide around $1,800/year or $150/month. However, the dividend income would decrease if we liquidated the portfolio for cash flow.
Our expenses are around $4,300/month. Without jobs, I estimate that we could reduce our expenses to around $3,800/month. This means that we would need at least $3,800 cash to cover our expenses while waiting for EI (assume $3k/month total EI income for both spouses).
Accounting for the initial cash requirement of $3,800 (waiting for EI), it would leave us with $8,200 in savings to cover the $650 monthly shortfall (counting dividends). This cash would last around 12.5 months which is approximately when employment insurance would run out.
Hopefully by this point, we would have employment lined up, but if not, we would need to dip into our portfolios or line of credit. If rates were to remain low like today (2.25%), it would be a toss up on whether to use the line of credit or liquidate our portfolio. The largest downside of the line of credit is that it would create an additional monthly expense, unless we were to capitalize the interest.
Liquidating a taxable portfolio has it’s downfalls as well. You could be forced to sell low, or even if you sell high you’ll face capital gains tax. If choosing to liquidate, it may be best to liquidate positions as you need the cash instead of liquidating everything at the same time.
If we were to liquidate the portfolio completely (to keep things simple) and deposit into a high interest savings account that keeps up with inflation, it would eliminate my $150/month cash flow and would mean that the $60,000 cash would last 15.7 months (accounting for inflation). At today’s market price point, there would be no capital gains tax payable on this amount.
So it looks like without going into debt, or dipping into our retirement savings, our expenses would be covered for up to about 28 months (assuming no big ticket expenses during that time.
So back to you, how long could you cover your expenses if you lost your main source(s) of income?