July 3, 2012, 5:29 am

Liquidity, Pension Plans and Paying off Debts, What’s Most Important?

by: The Financial Blogger    Category: Financial Planning
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Last week, I posted my net worth statement showing a great increase in terms of net worth and, unfortunately, a big increase of my debts also! Lance @ Money Life & More pointed out that my asset increase was based on illiquid assets:

 

My Pension Plan (+29.2%)

My Home (+1.7%)

My Online Company Shares (+34.2%)

 

These three assets grew by $48K! This wasn’t a 1 month increase but a yearly update that I do. It was a coincidence that we reassess the value of our company and I received my pension plan statement in the same month. Since I added a pool to my house, I decided to increase my house value at the same time. Nevertheless, none of these assets are liquid. My pension is frozen for the next 30 years, my house would take six to twelve month to sell and my online company shares are based on a personal assessment and I doubt I would be able to sell them overnight. The assigned value is more to reflect the dividend it generates as a “real” cash flow into my pocket.

 

Is Liquidity a Problem?

 

One of the basics of financial planning is to acquire insurance… and then an emergency fund. You can build you emergency fund with two techniques:

 

1-      You put money aside

2-      You open a line of credit that you don’t use

 

In my financial structure, I have decided to use my employer stocks as my emergency fund. I invest about $650 per month so my emergency fund is building up quickly. I do have a risk of market fluctuation. If the stock was to fall by 50%, I would lose 50% of my emergency fund temporarily (this is what happened back in 2008!). However, since my employer is adding 25% to my savings, I have a buffer of 25% + a dividend yield of almost 4% before losing “my money”. I preferred this way of savings instead of dropping my cash into a money market fund at 1%.

 

I Have Too Much in Illiquid Assets

 

While I’m happy with the way I’ve setup my emergency fund, I’m not happy with my overall asset allocation. Besides my employer stocks, I have no other assets that can be accessed quickly. I do have my RRSP account (which is a retirement account) but I would be taxed fully on any withdrawals. This is definitely not a good strategy! When you think about it, most people are stuck in the same situation; they have a house, a retirement plan and… nothing else on the side.

 

After I got my pension statement last week, I’m questioning my strategy on one point: should I contribute the maximum into my RRSP? I’ve been maximizing my RRSP contribution for the past five years. Therefore, I have no more contribution room but the current year. When I looked at my pension statement, it shows that I could retire at the age of 55 with a 48K pension. At the age of 60, I would reach $55K. If I wait to take my full pension at 65, I would reach a 70K annuity!

 

Therefore, everything I put aside in my RRSP would be added to this pension. This sounds like gravy to me. This is why I’m now thinking of using my year-end bonus to invest in a Tax Free Savings Account (TFSA) instead of contributing to my RRSP. This would increase my liquid assets and would not hurt my retirement too much. On top of that, my RRSP withdrawals would be taxed on top of my pension payment and my TFSA withdrawals would be tax free. This is something to think about!

 

Paying Off Debt

 

The other option I have with my year-end bonus is obviously to pay off debt. I’m already putting the focus on this part of my balance sheet this year. I’m still debating regarding what I’ll do with my “last” 5K (investing it in a TFSA or paying off more debts). The thing is that I don’t pay much interest on my debts and this is why it’s tempting to invest instead of paying off more debt.

 

Dropping the balance on my line of credit would increase my emergency fund and liquidity. This would be a pretty good idea too! On top of that, it would help me protect my financial situation in the event of interest rate increase.

 

Are You Liquid?

 

My guess is that I’m not the only one in this situation; are you liquid? Do you have a lot of money in a money market fund? Do you have access to a big chunk from your line of credit?

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Comments

I am VERY liquid right now probably too much for a 30 year old. I have been saving cash for a 20%+ down payment on a home in the next 6 months or so.

Even after the home purchase I will probably keep myself pretty liquid b/c I have the risk tolerance of an 80 year old grandmother lol

Do you think you are just trying to make yourself feel better by arbitrarily increasing your company’s worth?

I do that sometimes too with my assets, so it’s understandable.

Glad I could provide some insight! Thanks for the mention as well! Liquidity can be a problem if you aren’t thinking about it but it sounds like you have a plan now 🙂 Always good to be aware of your full situation.

by: The Financial Blogger | July 4th, 2012 (6:19 am)

@Evan,
you’ll never suffer from money stress :-D. good job on saving a lot of money for your cash down. Too many people aim for the minimum 🙁

@Joe,
I don’t increase the value of my company for fun. We actually do it once a year with a very specific methodology. The number could also go down if we make less money.

@Lance,
thx for your comments, it’s always appreciated 😀

Paying off debts is always number one for me. Lets face it they are a bit of a burden on the mind and also I tend to think of what I could do with the money that I would usually be paying the debts off with. No point having savings at the moment either so unless there is a fantastic investment opportunity staring you in the face then paying off outstanding debts is a good thing.

Everything I have is liquid.. the only possible exceptions are IRA accounts which involve a penalty if I were to withdraw early.

I also think I should be “doing something” with my liquid assets. But what? I haven’t found anything. Manhattan real estate’s future is too uncertain for my tastes.

To answer the question in your post.. I would agree that too many of your assets are illiquid, and add that too much of your debt IS liquid. If you get any year-end bonus, then after that obligatory nice steak dinner, pay off debt. You keep talking about wanting to do this…almost like the smoker who keeps saying he has to quit. But perhaps you don’t really WANT to pay off your debt?

[…] These three assets grew by $48K! This wasn’t a 1 month increase but a yearly update that I do. It was a coincidence that we reassess the value of our company and I received my pension plan statement in the same month. Since I added a pool to my house, I decided to increase my house value at the same time. Nevertheless, none of these assets are liquid. My pension is frozen for the next 30 years, my house would take six to twelve month to sell and my online company shares are based on a personal assessment and I doubt I would be able to sell them overnight. The assigned value is more to reflect the dividend it generates as a “real” cash flow into my pocket.Source: thefinancialblogger.com […]