Variable Income, High-Interest Debt, and No Disability Coverage
Tessa, 41, is a self-employed graphic designer whose net income ranges from $110,000 to $160,000. Her spouse Marc, 43, earns $92,000 as a teacher. They have two children, ages 8 and 11. Debts: mortgage $385,000 at 5.15% with 22 years remaining; HELOC $28,000 at 7.2% from a kitchen renovation; credit card $14,000 at 20.99%; car loan $19,000 at 6.9%. Assets: chequing $4,000; emergency savings $3,000; TFSAs $22,000 combined; RRSPs $180,000; RESP $12,000; home valued at $780,000. Tessa has no disability insurance and no work benefits. Marc has group disability covering 60% of salary. They want to maximize RESP contributions, pay down debt, and retire at 62. Tessa expects a $25,000 inheritance within six months. Their 2024 tax refund was $6,800, which they spent.
1. Rank the family's financial priorities for the next 12 months and explain how the $25,000 inheritance should be allocated.
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Ranking logic: compare the after-tax, risk-adjusted return of each use of cash. Paying the credit card is a guaranteed 20.99% return, far above any expected investment return. Next is a basic emergency reserve because Tessa's income is variable and she has no disability coverage. The RESP grant is a 20% immediate return on the first $2,500 contributed per child, but it should not come before avoiding new high-interest debt.
Suggested allocation of $25,000:
- $14,000 to eliminate the credit card.
- $6,000 to emergency savings, bringing the reserve to $9,000 (still below three months of fixed costs).
- $5,000 to RESPs, split to capture at least $1,000 in Canada Education Savings Grants.
Redirect the monthly surplus: first build the emergency fund to three to six months of fixed expenses, then pay down the HELOC, then increase RESP contributions. The refund should be treated as planned income, not spending money. The mortgage is low priority relative to the credit card and HELOC because its rate is lower and the interest may not be deductible.
2. Assess Tessa's disability insurance gap and recommend coverage features.
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Tessa has no disability coverage and no group benefits, so a prolonged illness would immediately pressure the family's cash flow and savings. Marc's group plan covers only his salary. Tessa should apply for an individual disability policy with:
- Own-occupation definition for at least the initial period, ideally to age 65.
- Benefit of 60% to 70% of income, using a two- or three-year average of her net income because it varies.
- 90-day waiting period to reduce premium, with emergency savings covering the wait.
- Residual or partial disability benefit, important for a designer who may return part-time.
- Cost-of-living adjustment and future-insurance option to increase coverage as income grows.
- Waiver of premium and a renewable-to-age-65 contract.
She should also consider business overhead coverage if she has fixed business expenses. Underwriting will use notices of assessment and may require medical evidence. The policy should be in force before she relies on it; do not cancel any existing coverage first.
3. How should the couple manage cash flow given Tessa's variable income and the goal to retire at 62?
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Build the household budget on Tessa's lower income, not her best year. Separate accounts for tax installments and GST/HST, and automate transfers on the first of each month. Hold the emergency reserve in a TFSA or high-interest savings account. In high-income years, increase RRSP contributions to reduce tax at the marginal rate; in low-income years, use the TFSA and RESP. Contribute at least $2,500 per child per year to capture the maximum grant, and use catch-up contributions if prior room exists. Review mortgage prepayment versus RRSP contributions annually: prepayment is a guaranteed after-tax return, while RRSP contributions defer tax but are less liquid. Finally, set a target retirement spending figure and test whether the combination of CPP, OAS, Marc's pension, and portfolio withdrawals can support it by age 62.