When Should Someone Declare Bankruptcy?
I am going to begin this by simply answering the question above and then explain the reasoning behind the answer: In my opinion someone should declare bankruptcy when they have a huge amount of debt $250,000+, low income and no assets of any significant value. This would be pretty much the ideal situation in which to go bankrupt.
Why is that a good bankruptcy scenario? When considering a bankruptcy one must understand the rules and the calculations of bankruptcy. Yes there are rules, strict rules. The two major considerations in bankruptcy are income and assets. Let’s tackle income first: To determine what your income requirements will be in the bankruptcy there is a calculation that states how much an individual can earn per month. If the earnings exceed the prescribed amount the overage is called “surplus”, so if you have surplus you will be required to pay 50% of that to the Licensed Insolvency Trustee (LIT) for at least 21 months. Here’s an example: As a family of one you can earn $2089/mth net income, so after taxes etc. are deducted. If you earn $3089/mth net that means you have a surplus of $1000/mth. If you go bankrupt you would have to pay 50% of $1000 which equals $500 for 21 months which would be a total of $10,500. You better have a lot more than $10,500 of debt or you are making a very bad decision. Now onto the assets: Many of your assets are exempt such as clothing, household goods and such. Exempt means that you do not have to surrender the goods or pay their value to keep them. However some assets are not exempt, such as the last 12 months of RRSP contributions, home equity over $10,000, vehicles worth more than $6600 (a vehicle loan can mitigate the value in a vehicle), RESP’s, windfalls of money such as lottery winnings or an inheritance, life insurance policies and more.
Example number two involving assets: You own a vehicle worth $10,000 and there is no loan, you have been putting way $300/mth into an RRSP for the last 5 years, and you have a $5000 motorcycle. So in this scenario there are many non-exempt assets which means you would either surrender the assets to be sold and the money given to your creditors or you would pay out the value of the assets to the Licensed Insolvency Trustee (LIT) for distribution to the creditors and you then keep the assets. So let’s say you want to keep the assets, here’s how that would look: Vehicle exemption is $6600 so you would have to pay the difference up to its $10,000 value, so $3400, $300/mth into an RRSP is $3600 year. Fortunately the 1st 4years of contributions will be exempt, but the last 12 months are not so that would be $3600. Finally the motorcycle is not exempt at all so you would have to pay the full value, $5000. So your total asset obligation would be $3400+$3600+$5000=$12,000. So to keep the above listed assets in a bankruptcy you would have to pay $12,000 during the term of the bankruptcy, typically 9 months ($1333/mth) or 21 months ($571/mth). So again, in this scenario there better be a lot more than $12,000 of debt or again the bankruptcy is a very poor decision.
So with all of that explained I’m sure the best time to declare bankruptcy is as clear as mud, right? The short and simple summary is that when the income falls close to or below the allowable amount and there are no significant assets the cost of bankruptcy will be very low no matter what the debt is. So if there is a lot of debt and the cost of bankruptcy is really low then it makes a lot of sense. Just be sure everything is what it appears to be and that’s where advice from your friendly neighbourhood 4 Pillars consultant can come in really handy.
When I meet with my clients and they have scenarios quite similar to what I’ve depicted above I explain to them that bankruptcy is a moving target. You are under the watchful eye of the LIT who will monitor your income, if it increases during the bankruptcy so will your cost of bankruptcy. If there are any acquisitions during the bankruptcy these could become assets to distribute to the creditors. There are severe penalties for trying to hide any of this so these rules must be abided by. In many cases it is best to avoid the bankruptcy as it can create a massive monthly payment requirement when there is surplus income and asset value. Many of my clients do not like the uncertainty of a bankruptcy and would rather resolve their debt in another fashion. In this case I recommend we look at a Consumer Proposal. I look at the details of their situation and help my clients structure the proposal to save them the most money possible. We would then file the proposal through a LIT which I carefully select based on my client’s situation, upon acceptance by the creditors my client now has one monthly payment, zero interest and no concerns about future wage increases, windfalls of money and they know their assets are safe. I will be writing a blog in the future to explain more about the Consumer Proposal process as it is too long to explain here. In short, make sure you get unbiased, professional advice prior to filing a proposal so you get the best settlement possible.
If you are struggling with debt and need advice on which process is best for your scenario please feel free to call me at 904-243-8765 for a free consultation.
About the Author:
Trevor Glasser owns the 4 Pillars Consulting Oshawa, On Office helping people get out of debt every day. If you need a free consultation to understand your options please feel free to contact Trevor at 905-243-8765 or www.goodbyedebt.ca.