Getting a tax refund is one of those things we are excited to receive. It’s almost like kids waiting for the last day of school with summertime just around the corner. Each year before you do your taxes, do you feel a bit queasy about not really knowing whether you will receive a refund or have to pay? You are not alone. Some simple planning can change this so you know every year before you even file. Wouldn't that be nice!
Here are a few options for your tax refund: (not in any specific order)
1. Blow it all on something crazy and when your done you'll wish you hadn't.
How many times has this happened? When I was in my 20's this was probably the option I chose most. I would actually plan what I was going to spend my refund on. Would it be a new motorcycle accessory or maybe a new slalom water ski to enjoy for the summer? Yes, I am dating myself with the slalom water ski. Maybe for you it’s the wake board. But whatever it is, we are all super excited to get a refund but then we spend it on a depreciating asset or something that gives us a temporary dopamine rush. Then we carry on waiting till next year. Just because I listed this as number one doesn't mean it should be the first choice. But it is probably the option people choose quite often from what I have seen. Definitely not good for any long term planning!
2. Reinvest your tax refund in a RRSP.
This doesn't sound very exciting today, but when you retire, the more money you have the more excited you will be.
Your financial situation and your retirement savings will determine whether this makes sense or not. Investing your refund in your RRSP will automatically be optimizing your tax deferred investments and increasing next year’s refund. But it does depend on whether you are already contributing to RRSP's, how much you are contributing, and what income tax bracket you are in. Will the extra contribution possibly bump you into another lower tax bracket? These are some of the questions to ask yourself. With a little preplanning you should have this figured out long before next tax time.
3. Invest your tax refund in a TFSA.
Some of you might not even know what a TFSA (Tax Free Savings Account) is and the majority of people are not utilizing a TFSA effectively. We have found that even people who have been using their TFSA are using them for short term savings. The real benefit is long term when you start taking money out during retirement and all the monies you receive are completely tax free. Sometimes this might help you stay in a lower tax bracket during retirement which could possibly reduce your OAS (Old Age Security) claw back. The downside to the TFSA is that you don't receive an initial tax deduction like an RRSP, but it is often outweighed by tax free income in the ‘golden’ years.
4. Pay down your mortgage or home equity line of credit with your tax refund.
Ultimately paying down debt is never a bad thing, but it is best to run the numbers. See what the effects of paying down your mortgage or line of credit will have on reducing your long term debt and how much time it will knock off.
5. Pay down high interest debt, like credit cards, with your tax refund.
I think this is a great option. Ultimately credit card debt erodes everything due to high interest costs. Remind yourself that to get ahead financially means having no high interest debt or credit card debt. You should be looking at getting some budgeting help if you need to solve this problem. Have a look at our tracker to get you started in the right direction. In the tracker there is credit card pay down help.
6. Use your tax refund to create or start an emergency fund.
Do you have an emergency fund? If not, this might be a great way to start. A good majority of people we see don't have an emergency fund. In fact many people are only a few hundred dollars from not being able to pay their bills. Not a good situation and one that causes a high level of stress.
Maybe you had to dip into your current fund for that roof that had to be replaced or that furnace that conked out, so you might need to replenish those funds. Is there a much needed house repair that has to get done before it creates more issues and more expenses? Often, these are going to happen at the worst times. Start planning ahead and stay prepared.
A few years ago one of our neighbors water tank eroded and the bottom fell out completely flooding their finished basement. They built their house at the same time as us. So I asked another couple neighbors and sure enough they had the same thing happen. So instead of waiting we just planned to have our water tank replaced before it caused more damage or an unnecessary insurance claim.
7. Top up your children's education (RESP) fund.
Do you have RESP's (Registered Education Savings Plans) for your children’s post-secondary education? Now I know there are several types of parents out there. Some say,
“I never had any help when I was a kid, so my kid will do it on their own”.
The other extreme is parents who pay for everything. The real kicker here is the government will give you an extra 20% in government money up to $500 each year. So in my mind, free money is always a good thing and it gives us an instant rate of return regardless of how the investments are doing. Our kids’ education is a major expense or investment depending on your point of view. If you aren't sure how much this is going to cost, you can check out one of our free resources. If you haven't set up an RESP yet, or would like to find out more, just reach out to us.
8. Use your tax refund to educate yourself.
Have you been dreaming about a side business or another job? Maybe taking the proper course to help you earn more money, get a raise, or start a side gig would be a good plan. I always look at education as an investment when you are doing it with the right intentions.
9. Top up your permanent life insurance with your tax refund.
Use your tax refund to get your permanent life insurance premiums paid up in a limited period of time. Did you happen to reduce the payment during some tough times and never pay it back? Not sure where you are at with your current permanent insurance and want a review? Just send us a message and we would be glad to help.
I am sure there might be a few more options, but these would be at the top of my list.
Here are a few things you have to remember about tax refunds:
If you are getting a refund it means the government has been sitting on your money throughout the year. So if you have your numbers tracked, you might want to put more in monthly registered savings and have payroll withhold less. This does take more effort in planning, but over the long term can really pay off.
Have a look at a simple calculator to see how putting more into your RRSP will affect your tax return. Maybe it will put you in a lower tax bracket. I will often suggest using a quick calculator from Intuit to see how making changes can affect your taxes and refunds.
If you really want to get things under control - start working with an advisor to help you.
As you can see, the theme behind any choice really comes down to what your current financial situation is and what you want it to look like in the future. No one strategy is good for everyone. Ultimately, building net worth should be a priority. Depending on what family stage you are at will determine what strategy is most important or most beneficial. The choice for you will depend on where you are at in life financially, what life stage you are at, where you want to be financially in your retirement years, or when you want to be completely debt free.
Financial Stress is one of the worst stressors in life and is often the cause of all kinds of other issues in our personal and work lives. Take control, as no one will do it for you. But, you don't have to do it on your own because help is available.