Tapping Your Portfolio for Some Quick Cash
Jan 12, 2023
Given the high inflation we have all experienced over the last 12 months, it comes as no surprise that many household budgets are being pushed to their limit.
In response, you may be considering dipping into your investment portfolio to create some additional breathing room.
Ideally, you already have an established emergency fund or low-interest line of credit that you can tap for unexpected cash needs. By having these facilities in place, you gain the flexibility to avoid selling when everything is in a slump and potentially avoid fees or losses that might result from selling and with- drawing from investments early.
However, if dipping into your investments is the only alternative to make ends meet, you should be aware of the different tax consequences that may arise depending on where you draw the cash.
Non-Registered Accounts
There is no tax on cash withdrawals from your personal or joint non-registered accounts. These withdrawals are no different than the cash withdrawals you make from your regular chequing or savings account at your bank. However, if you sell an investment such as a stock, bond, or mutual fund to generate the cash, it will likely result in a taxable capital gain or loss.
A capital gain is simply the profit over the original amount you invested. Currently, only 50% of capital gains are taxable at your marginal tax rate (the tax rate you pay based on your total income for the year).
A capital loss occurs when you sell an investment for less than the original amount invested. These losses do have value, in that 50% of the loss can be used to offset or reduce your taxable capital gains.
Capital losses can only be used to reduce capital gains and cannot be applied to any other type of income such as income from employment or income from a business.
If you don’t have any capital gains or losses in the current year, net capital losses can be carried back three years to reduce prior taxable capital gains you may have incurred or carried forward indefinitely to offset future capital gains.
Tax-Free Savings Account (TFSA)
As the name suggests, any withdrawals from your TFSA are completely tax-free. There is no capital gains tax or tax on any investment income such as dividends or interest. Since no tax is applied on TFSA accounts, the Canada Revenue Agency does not allow the deduction of any capital losses on investments sold for a loss.
One of the great features of TFSA accounts is that you are allowed to replace any amounts you withdraw and therefore you don’t lose any TFSA contribution room.
For those that contribute the maximum amount to their TFSA account each year, you will need to wait until the next calendar year before you can replace any withdrawals.
Home Equity
You can borrow against the equity in your home using a home equity line of credit or a reverse mortgage. Both are loans secured by the equity in your home, and interest is charged on the amount borrowed. Any amounts that you borrow are not taxable.
Home equity lines of credit have been the most common solution for homeowners who need cash, but rising interest rates have increased the interest cost significantly. The interest rate on these loans is typically a bank’s prime lending rate (currently ~6.45%) plus 0.5%, or 6.95% total.
Reverse mortgages typically have fixed interest rates, which are currently in the 7.5% – 9.5% range.
Registered Retirement Savings Plans (RRSPs)
Withdrawals from an RRSP are fully taxable based on your marginal tax rate in the year of withdrawal unless the funds are withdrawn for a down payment under the Home Buyers’ Plan or for continuing education under the Lifelong Learning Plan.
A withholding tax is applied on RRSP withdrawals, and varies depending on the amount withdrawn but tops out at 30% on withdrawals of more than $15,000.
For most people, RRSP withdrawals should be considered a last resort because you lose out on the tax-deferred compounding benefits RRSP accounts provide. This means even small withdrawals can have a big impact on your total savings later at retirement. Additionally, when you withdraw funds from an RRSP, you permanently lose the contribution room you originally used to make your RRSP contributions.
There can be some cases where an early RRSP withdrawal makes sense, such as a tax year when you have little to no income and can therefore withdraw the funds at a low marginal tax rate, but these cases are rare.
Because everyone’s circumstances are different, you should consult your advisor so they can advise on the best way to withdraw funds from your portfolio for your specific situation. ■
In response, you may be considering dipping into your investment portfolio to create some additional breathing room.
Ideally, you already have an established emergency fund or low-interest line of credit that you can tap for unexpected cash needs. By having these facilities in place, you gain the flexibility to avoid selling when everything is in a slump and potentially avoid fees or losses that might result from selling and with- drawing from investments early.
However, if dipping into your investments is the only alternative to make ends meet, you should be aware of the different tax consequences that may arise depending on where you draw the cash.
Non-Registered Accounts
There is no tax on cash withdrawals from your personal or joint non-registered accounts. These withdrawals are no different than the cash withdrawals you make from your regular chequing or savings account at your bank. However, if you sell an investment such as a stock, bond, or mutual fund to generate the cash, it will likely result in a taxable capital gain or loss.
A capital gain is simply the profit over the original amount you invested. Currently, only 50% of capital gains are taxable at your marginal tax rate (the tax rate you pay based on your total income for the year).
A capital loss occurs when you sell an investment for less than the original amount invested. These losses do have value, in that 50% of the loss can be used to offset or reduce your taxable capital gains.
Capital losses can only be used to reduce capital gains and cannot be applied to any other type of income such as income from employment or income from a business.
If you don’t have any capital gains or losses in the current year, net capital losses can be carried back three years to reduce prior taxable capital gains you may have incurred or carried forward indefinitely to offset future capital gains.
Tax-Free Savings Account (TFSA)
As the name suggests, any withdrawals from your TFSA are completely tax-free. There is no capital gains tax or tax on any investment income such as dividends or interest. Since no tax is applied on TFSA accounts, the Canada Revenue Agency does not allow the deduction of any capital losses on investments sold for a loss.
One of the great features of TFSA accounts is that you are allowed to replace any amounts you withdraw and therefore you don’t lose any TFSA contribution room.
For those that contribute the maximum amount to their TFSA account each year, you will need to wait until the next calendar year before you can replace any withdrawals.
Home Equity
You can borrow against the equity in your home using a home equity line of credit or a reverse mortgage. Both are loans secured by the equity in your home, and interest is charged on the amount borrowed. Any amounts that you borrow are not taxable.
Home equity lines of credit have been the most common solution for homeowners who need cash, but rising interest rates have increased the interest cost significantly. The interest rate on these loans is typically a bank’s prime lending rate (currently ~6.45%) plus 0.5%, or 6.95% total.
Reverse mortgages typically have fixed interest rates, which are currently in the 7.5% – 9.5% range.
Registered Retirement Savings Plans (RRSPs)
Withdrawals from an RRSP are fully taxable based on your marginal tax rate in the year of withdrawal unless the funds are withdrawn for a down payment under the Home Buyers’ Plan or for continuing education under the Lifelong Learning Plan.
A withholding tax is applied on RRSP withdrawals, and varies depending on the amount withdrawn but tops out at 30% on withdrawals of more than $15,000.
For most people, RRSP withdrawals should be considered a last resort because you lose out on the tax-deferred compounding benefits RRSP accounts provide. This means even small withdrawals can have a big impact on your total savings later at retirement. Additionally, when you withdraw funds from an RRSP, you permanently lose the contribution room you originally used to make your RRSP contributions.
There can be some cases where an early RRSP withdrawal makes sense, such as a tax year when you have little to no income and can therefore withdraw the funds at a low marginal tax rate, but these cases are rare.
Because everyone’s circumstances are different, you should consult your advisor so they can advise on the best way to withdraw funds from your portfolio for your specific situation. ■
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