Ten Ideas for Your Tax Refund
After the cloudy days of preparing and filing your tax return, many Canadians look forward to the silver lining of a tax refund. Last year I wrote about The Problem with Tax Refunds, arguing that rather than a benefit, refunds represent an interest-free loan to the government. Nevertheless, refunds are common, especially if you have contributed to an RRSP. Given this is routine for many, what are some options to consider, and which might you consider a priority?
1. Pay Off Debt
Paying off debt, especially high-interest debt, is an excellent use of a refund. With interest on credit cards running at 20% or higher, if you find yourself carrying a balance on your credit card, then using your refund to get that balance back down to zero can make a meaningful difference. In addition to credit cards, personal loans, and unsecured lines of credit charge fairly high interest rates, too. Paying these off will provide a meaningful benefit.
If you borrowed to contribute to your RRSP, that refund can be used to pay off the loan.
2. Invest in Your Retirement (RRSP)
Even if you didn’t borrow to contribute to your RRSP, you can still use your surplus to kickstart your RRSP contributions for the current year. If you’ve gotten your Notice of Assessment, you know exactly how much you can contribute for the current year and the refund will help you get there. Then the balance you need to maximize your contributions is reduced because the refund already takes care of a chunk of your room.
Contributing this way is akin to a virtuous cycle. An RRSP contribution in one year will generate a refund that can be used to contribute the following year, which will again generate a refund, etc.
Since RRSP contributions grow tax-deferred inside the account, you know that ultimately, the withdrawals will be taxed, hopefully at a lower rate. Plowing that refund back into your RRSP is one way of preparing for that day when the CRA comes calling.
3. Invest in a Tax-Free Savings Account (TFSA)
Maybe you are very diligent about contributing to your RRSP. Your marginal tax rate (the rate you pay on your next dollar of taxable income) may be high enough that the deduction and consequent refund you receive make it very much worth your while to maximize RRSP contributions. In that case, you may already have the money set aside to fully contribute to your RRSP. The best alternative is to take advantage of any unused contribution room in your TFSA. You won’t get a tax refund but the investments inside the TFSA will grow tax-free and you will get tax-free income whenever you choose to withdraw from the account later.
4. Invest in a Registered Education Savings Plan (RESP)
For many Canadians, saving for their children’s post-secondary education is a high priority. If you are saving adequately for your retirement, then your tax refund can be a useful chunk of money to build up an RESP for your children. Because RESP contributions grow tax-free while in the plan, contributions can attract government grants, and the growth and grants are taxed in the hands of the beneficiary children, there are some tax opportunities available, including tax-splitting with your children.
Other Saving Options
5. Emergency Fund
Debt may not be a problem for your right now, but if you would be unable to cope with an irregular expense – replacement of a furnace, roof, major appliance, vehicle repair, etc. – then having some money set aside for those kinds of expensive if inevitable events should assume a high priority.
6. Upgrade Your Home or Car
This is similar to the emergency fund except it involves getting ahead of the emergency expense. If repairs to your vehicle are becoming increasingly common, then maybe it’s time to get a new one. A tax refund is unlikely to be large enough to pay for a new car, but it might provide a healthy down payment. Maybe the fence around your backyard is looking a bit wobbly. That tax refund may make just the financial difference you need to get that job done.
7. Save for a Down Payment
In many parts of Canada, it is exceedingly difficult to buy a home. A savings plan for a house purchase can include your tax refund. Perhaps the refund can go into the new-for-2023 First Home Savings Account (FHSA).
8. Save for a Specific Goal
If you are planning a big wedding or a once-in-a-lifetime vacation, you may wish to save that refund as seed money for that big event. Money is money regardless of where it comes from so there is nothing sacred about a tax refund that it can only be used for “practical” matters.
9. Buy Insurance
Here I am thinking about two types of insurance in particular. The first is disability insurance. If you or your loved ones depend on your income for the basic costs of living, then disability insurance is a must. If you become disabled for an extended period, whether through illness or injury, your savings are only going to take you so far. While some may view the group disability benefit provided by their place of employment as sufficient, not all Canadians have access to that option. The same can be said for life insurance. If you have a spouse and/or children who are dependent on your income for their livelihoods, then consider the adequacy of your current coverage, if any, and use your refund to address the gap.
10. Donate to Charity
If you have “all your ducks in a row,” debt is under control, RRSPs, TFSAs, and RESPs are fully funded, your emergency fund is in place, appliances and mechanicals that protect your household are regularly upgraded, savings for short and medium-term goals are taken care of, and you have the insurance you need, then consider a donation to a registered charity. There is, first of all, the psychological or spiritual benefit that is experienced when you can see that your money has made a difference in the lives of people in need or a cause that you believe in. Second is the tax credit you can use to apply against your taxes and perhaps help generate another refund.
No doubt there are other ideas that you can think of, or variations of the ideas presented here that are more meaningful to you personally. Regardless of what those ideas may be, I encourage you to reflect thoughtfully about how you might use a tax refund in a way that is helpful to you.
This is the 196th blog post for Russ Writes, first published on 2023-05-08
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.