How a young family can make the best use of an insurance payout

Q. I recently received a payout from a critical illness insurance policy. I now have a lump-sum, tax-free amount of $200,000 and need to figure out how to spend and invest it wisely. So far I can still work and do not have any major medical expenses that we need to pay for. My husband, Tom, and I really want to maximize this opportunity to boost our finances, but we are not quite sure how to go about it. We would appreciate any advice.

Our preliminary plan is as follows:

1. Pay off any consumer debt (about $4,000).
2. Top up both our TFSAs (about $86,000 of contribution room between us).
3. Top up the RESPs for our three kids (we usually contribute weekly to a total of $2,500 per child, per year, so the maximum amount we will contribute this year—including a new account for our baby—would be $7,500).

We also have accumulated room in our RRSPs from past years. I have $82,000 of accumulated room and Tom has $43,000. We are not sure if the best move is to put as much as we can into our RRSPs—and, if we do, what is the best way to do it? For instance, should we claim all of our RRSP contributions in one year, or over a few years?

Other points we need to consider:

1. We have a $200,000 mortgage at 3.49% for another three-and-a-half years. Should we put down some of the money on it? Our thought is that we could ideally make a higher return by investing the money within our TFSA and RRSPs, rather than put the money on a mortgage right now…but we aren’t sure.
2. We will most likely need to purchase a vehicle (a van) in the fall, and that will cost us about $30,000. What would be the best way to put that money aside and get some interest on it before we need to make the purchase?
3. Finally, we were wondering if it would make sense to get an advisor to help us make a plan for how to invest what is in our TFSA and RRSP accounts already. If so, what type of advisor do we look for?

–Katie and Tom

A. Katie and Tom, you find yourselves in an enviable position. The $200,000 payout presents a great opportunity to supercharge your investment plans. However, at this stage of your lives, you have many areas of your finances vying for attention. Here’s how to prioritize.

First, your plan to pay down your consumer debt is a prudent one. Debt reduction—especially higher-interest consumer debt, such as credit card balances, where you may be paying more than 20% in interest—is one of the best investments you can make. So that should be your first step.

There may also be good reasons to spread your money across TFSAs, RRSPs and the mortgage. For many people, this is an ongoing conundrum and there is really no one-size-fits-all correct answer for everyone.

Individual salaries and tax rates are often key in deciding how much money to allocate where, as are other cash management issues and your overall financial situation. In a perfect world, we would fully contribute to both the TFSAs and RRSPs and at the same time, also aggressively pay down the mortgage. However, much of the time this is not feasible.

Katie, you mentioned you’re considering “holding off,” or waiting a bit, before making more aggressive payments on your mortgage, as well as wanting to give more attention to your investments. If your investments are in a good mix of growth and dividend-paying stocks, your overage long-term investment returns would likely be greater than your existing mortgage rate. In this case, paying down the mortgage would likely not be your first priority.

Even so, you may also want to consider paying down a portion of your mortgage. A lump-sum amount—even a modest $10,000 or $20,000—put toward the mortgage principal can significantly reduce the amount of interest one pays in total on the life of the mortgage. Making a mortgage prepayment provides a huge psychological boost, too.

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Katie and Tom, given that you are a fairly young, perhaps your salaries are not at the point where the tax deduction from a large RRSP contribution is significant and impactful. RRSP contributions trigger larger tax deductions (and possible refunds) at higher salary levels (say, $80,000 or more). If both of you have salaries that are modest but still growing, putting some of the critical illness payout money in each of your TFSAs is a better choice right now. Investments in those TFSAs will generate solid, tax-free returns for a lifetime—leaving the RRSP contributions for a later time when salaries are higher and the tax benefit will be greater.

Still, because you are not required to claim the tax deduction from RRSP contributions in the year the contribution is made, you have the option of contributing now and “spreading” the tax deduction over a few years. If you want to consider this plan, you should speak to a tax accountant and see how this deduction approach can be of maximum benefit to you over the coming years.

Remember, TFSAs provide more flexibility than RRSPs. The money inside TFSAs can be allocated to shorter-term goals and objectives (like saving for a down payment on a cottage, as payment for tuition towards upgrading your professional skills in the coming years, etc.), or to longer-term goals, including retirement. An RRSP, however, is an investment that will generally have more impact at retirement.

Since you have significant outstanding contribution room for both your RRSPs and TFSAs, it may be prudent to allocate significant sums to all of these plans. One possibility is to maximize contributions to each of your TFSAs and then contribute $30,000 to $40,000 or so toward each of your RRSPs. Again, an accountant can help you decide the most tax-efficient way to make this contribution.

You don’t say how old your children are, but putting money aside in RESPs for them should continue to be a priority. Just make sure the money is invested in a good mix of growth and fixed income investments to have the best chance of getting good returns in the accounts before the kids go off to post-secondary school. You are already on the right course with your RESP investments.

When the time comes to replace your vehicle, you may want to consider vehicle financing at that time rather than using cash reserves that may be better allocated to other areas of your investment plans. Consider buying a vehicle directly from the vehicle manufacturer (and not the dealership). Over the last few years, such manufacturer financing has been at interest rates below 2%—and occasionally even at 0%. The “cost of money” with the financing option over a five-year term at the prevailing rates is under $1,000—so very affordable.

And while many families no longer consider an emergency fund an important piece of their financial puzzle (preferring instead to lean on a line of credit if necessary), it’s a good idea for young families like yours to have one. Medical emergencies, house or car maintenance emergencies, and other unforeseen financial events can happen at a moment’s notice. It’s best to be prepared and have the money easily accessible. Consider keeping at least enough money to cover three months of living expenses in an account to cushion for just such emergencies.

Finally, you may want to seek out the help of a fee-for-service financial planner. These professionals offer an objective, unbiased opinion on your finances and can help you put together a financial plan that would keep you on track to meeting your financial goals over the next few years. Many offer a free 30-minute consultation (either by phone or in-person) and do not sell any financial products. Do a quick Google search to find planners in your area. Interview two or three and settle on one you feel comfortable with. For financial well-being, what gets monitored gets improved. By finding a good fee-for-service planner, you can help ensure your financial goals will be met—whether it be with your homeownership goals, investments, or retirement planning.

Heather Franklin is a fee-for-service financial planner in Toronto.

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