June 28, 2018

Smart ways to use your tax refund

A man with a backpack contemplates using his tax refund. A man with a backpack contemplates using his tax refund.

There’s at least one pleasant thing about doing your taxes: the possibility of getting a refund. According to figures Opens in a new window from Revenue Canada, just over half of the nearly 25 million tax returns filed in 2017 received a refund, at an average amount of $1,670.

If you do receive a refund, you need to decide what to do with it. The temptation to spend your refund immediately can be strong – who doesn’t want a vacation, a new vehicle, or that kitchen renovation you’ve been dying to start. However, it’s important to consider all your options, such as paying down debt or saving for the future.

Whether you are embarking on your career, starting a family or saving for a down payment on a home, below are some suggestions about smart ways you can put your tax refunds to use.

1. Pay down debt… especially high-interest debt

According to a survey Opens in a new window conducted by Global News at the end of 2017, the demographic saddled with the most debt appears to be Generation X (loosely defined as people aged 35-54), who report an average debt of over $10,000, not including their mortgage. This includes credit card debt, which can carry interest rates nearing 20%. Monthly payments at such high rates can quickly eat a big hole into your budget.

The Financial Consumer Agency of Canada (FCAC) offers advice on how to manage your debt Opens in a new window. It recommends tackling higher-interest debt first, such as payday loans and credit cards, which will help lower your interest costs and free up more money to reduce your overall debt burden.

Once you’ve identified which debt to prioritize, you can develop a strategy for paying it. Mortgages are a common form of debt for many Canadians. The FCAC suggests strategies for paying off your mortgage faster, including a lump-sum payment and raising the amount of your regular payments.

The debate about whether you should invest your money or use it to pay down debt is vigorous and ongoing. This choice depends heavily on prevailing interest rates, the amount you owe, and your specific financial situation. Online calculators Opens in a new window can be a great resource for helping you to decide whether paying down your debt is the right choice for you.

2. Save for retirement

The internet it littered with sobering statistics about Canadians not saving enough Opens in a new window for their retirement. Government programs such as the Canada Pension Plan and Old Age Security will provide a basic income for many Canadians in retirement, but you need to consider your own retirement wants and needs in deciding how much additional savings you accumulate. A 2018 survey from CIBC found Canadians believe they will require on average $756,000 Opens in a new window in retirement savings, which contrasts sharply with the reported $184,000 in average savings.

The good news is that the earlier you start saving, the more your money could grow Opens in a new window with the benefit of prudent investment choices.

A Registered Retirement Savings Plan (RRSP) is the most well-known retirement savings vehicle in Canada. It allows you to contribute money each year, while avoiding taxes on those contributions until you withdraw it later in life (hopefully at a lower tax rate). In fact, RRSP contributions can help increase the amount of money you receive as a tax refund.

Tax Free Savings Accounts (TFSAs) are another great vehicle for long-term savings, as any capital gains you accumulate inside a TFSA are not taxable.

Luckily, there is no shortage of options when it comes to saving your money for retirement. Great-West Life offers a range of saving and investing solutions, including mutual funds and more comprehensive retirement plans.

3. Save for other long-term goals

There are plenty of reasons to save beyond the long-term goal of retirement. The FCAC recommends Canadians set up an emergency fund to cover unexpected expenses, such as the loss of employment or a medical emergency. An emergency fund can be set up gradually, with small weekly contributions to a dedicated savings account. You can also use part of your tax refund to set up a base from which to build over time.

This process can also be applied to other savings goals, such as a wedding or a down payment on a new home. You can set aside a portion of your tax refund, and then make smaller contributions on a regular basis to achieve your objective.

4. Save for a child’s education

If you are expecting a child, or are the parents of a recent newborn, you’ve probably thought at least in passing about the costs associated with your child’s education. The average cost for a year of undergraduate tuition in Canada hit $6,571 in 2017, reports Opens in a new window Statistics Canada. And tuition levels are widely expected to continue rising. Luckily, there are government programs to help you save money for your children, the most well-known is the Registered Education Savings Plan (RESP).

You can open an RESP as soon as your baby is born. The earlier you start saving, the more you can potentially grow your money by the time he or she is ready for post-secondary studies. The federal government will contribute up to $500 per year to any deposits you make into an RESP (based on a formula of matching your own contributions to the account at a rate of 20% annually). So if you’re contributing less than $2,500 each year (about $200 per month) to your child’s RESP you’re missing out on those government amounts.

5. Buy life insurance

If you have young children or are expecting one soon, you should consider buying life insurance if you haven’t already. According to a recent survey Opens in a new window conducted by the investment firm Edward Jones, less than a third of Canadians have insurance coverage for “unforeseen life events” such as a death or a serious illness.

This is important, because you’d want your children to be financially secure if the unthinkable were to happen to yourself or anyone else who is a primary caregiver. The two most common types of life insurance are term life insurance – a more affordable option that covers you for a specific period, and whole life insurance – which offers coverage plus the opportunity to accumulate cash value within the policy on a tax-advantaged basis .

However you decide to use your tax refund – retirement savings, debt repayment or buying insurance – a financial advisor can help you make the decisions most suited to your current financial situation.

The information provided is based on current tax legislation and interpretations for Canadian residents and is accurate to the best of our knowledge as of the date of publication. Future changes to tax legislation and interpretations may affect this information. This information is general in nature, and is not intended to be legal or tax advice. For specific situations, you should consult the appropriate professional advisor.

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