Lost Your Job? Income Smoothing Can Help

It doesn’t take much to be restructured out of a job these days. And for many families, it can be a painful time both financially and emotionally. But it doesn’t have to be.

There are a few things you can do to make those weeks—maybe even months—without a pay cheque less financially draining on your family’s finances.

To start, if you’re one of the lucky ones, you will have been given severance pay, depending on how long you’ve worked with your company. This could amount to several thousand dollars and that money can get you through the first few weeks fairly unscathed. Of course, many won’t have the luxury of decent severance so in those cases a family has several options to maximize the money they’ve earned and saved over the years by being strategic in how they use their savings or take on debt. Here are a four tips to help you strategize your family’s income.

  • If you have an emergency fund that you’ve contributed to faithfully while working, then that is where you should access money for household expenses first. “I like to see an emergency fund that can cover three months worth of net expenses,” says Avraham Byers, a Toronto cash-flow specialist. This includes shelter, modest food budget, utilities and basic transportation. You can add back frills for spending like dining out and gym memberships when you start a new job.”
  • Depending on your family’s tax situation, it makes sense to know what types of income to draw down first for maximum tax savings. This is called income smoothing, and its affect is to save you tax dollars. So if you have any stocks or mutual funds in unregistered trading accounts—and those securities have decent capital gains—consider strategically cashing some of those investments in. You’ll likely be in a lower tax bracket so taxes on capital gains will be lower than if taken out in a high income year.
  • If your family doesn’t have any unregistered investments, but you find you still need more cash, then the Tax Free Savings Account is the first account that should be tapped. “The TFSA isn’t age or income dependent and it doesn’t have the restrictions that RRSPs have when it comes to putting money back into it once you start earning income again,” says Byers.
  • Generally speaking, your last resort should be withdrawing money from your RRSP. Both Byers and certified financial planner Heather Franklin say these are meant for long-term savings and retirement, and if money is withdrawn, you won’t be able to put that money back in at a later date. “The contribution room doesn’t magically reappear, so I wouldn’t suggest this strategy,” says Franklin. Still, if one spouse will be in a low tax bracket that year—and this could be you or your spouse—it may be worth taking some money from an RRSP or spousal RRSP. Since RRSP withdrawals are taxable, one spouse withdrawing from an RRSP in a low-income year could save your family money in the long run. If this is the case, consider withdrawing a modest amount—under $5,000—to avoid boosting yourself into a higher tax bracket, with the implication that you would have to pay more tax next April than anticipated. “I think people cash out their RRSPs first and don’t even realize until they get their tax bill the following year that tax will likely be due on that money,” says Byers. “Remember, you never get that contribution room back. So withdrawing from long-term savings like RRSPs can be done strategically, but only if you have a very good idea of your tax situation that year. Otherwise, leave it alone.”
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