How to Make Your Tax Refund Work For You
March 31, 2020
It’s always a good feeling to receive a refund after you’ve filed your annual income tax return. Still, while tax refunds are undoubtedly good news, they’re not exactly cause for exuberant celebration. What the refund really means is you’ve been paying more tax than you needed to, essentially lending money to the government until they give it back.
Whether your refund is big or small, it shouldn’t be seen as an excuse to spend, spend, spend, especially in these uncertain times. That’s not to say you can’t spoil yourself a little bit but resist the urge to spend it all at once.
If you’re looking for a wiser way to put your tax refund to work, here are a few ideas worth considering.
Pay down your debts
When choosing which debts to reduce, compare the interest rate you’re paying on each obligation, and the amount of money owed. Ideally, you’ll be able to pay down the one with the highest rate, or the one with the largest remaining principal. Credit card debts often have punitive interest rates, making them an obvious target, but those with second or third mortgages often face steep rates, too. If you’re a smart spender and don’t carry a balance on your credit card, try tackling a student loan or car loan.
There’s a positive double-whammy that comes from paying down or paying off debt. First, you reduce the amount you’ll end up paying in interest over the long term. Second, you free up more of your regular income for other uses.
Whatever kind of debt you decide to deal with, make sure you’re aware of any prepayment penalties that could potentially eat into your savings.
Invest for the future
Plan for a stable financial future by investing your tax refund into a Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA). Each of these strategies offers an additional benefit beyond the potential investment growth. First, contributions to a RRSP are tax-deductible, reducing your tax burden for the next filing period. With TFSAs, you don’t pay income tax on the earnings generated within the account, helping your savings grow more quickly.
If you’ve got children, consider contributing to a Registered Education Savings Plan (RESP). While this won’t give you an immediate tax benefit, it’s still a wise move as the income generated by the investment is tax-free. Plus, once the money is eventually withdrawn, it will likely be taxed at a lower rate.
Savers who don’t have any remaining contribution room to add to a RRSP, TFSA, or RESP can choose to invest their refunds in taxable accounts containing stocks and bonds, or any kind of investment product. If market instability is a concern, look at term deposits and other more stable investment vehicles.
Start, or supplement, a savings account or emergency fund
Tax refunds can help you reach important savings goals. If you’ve been trying to put money aside for a dream vacation or home renovation project, park your tax refund in a savings account, preferably one that pays high interest.
Your refund can also be used to top up an emergency fund for times of need, something to help pay the bills in case you lose your job or suffer ill health. Most financial experts agree on the wisdom of having the cash equivalent of three to six months of salary saved up somewhere in case you suddenly find yourself in a position of serious financial hardship.
Spend on something that will save you money
Whether it’s a high-efficiency furnace, new windows and doors, additional insulation, or updated appliances, your refund can go toward items that will bring down your monthly bills and reduce your overall cost of living. Investing in your home will also increase its resale value, putting more money in your pocket when you decide to sell or move.
If you want to mitigate against costly risks, you could use some or all of your refund to purchase expanded insurance coverage, giving you financial security in case of an unforeseen accident or natural disaster.
Invest in yourself
Looking to learn a new language, or master computer programming? If you’ve been wanting to learn a new skill, use your refund to pay for courses and classes that enhance your qualifications and make you a more attractive employee. You might even end up earning a higher salary as a result.
Alternatively, you could use your refund to help launch a side-business that complements the income from your current job. Whether you stock up on supplies for an online store or spend on marketing for a new venture, your tax refund could be an important investment in your future success and happiness.