More than eleven million Canadians have already filed their taxes according to the Canada Revenue Agency (CRA). As of April 6, the average refund works out to quite a sizeable chunk of change: $1,788.
While many people view a tax refund as a windfall of free cash, in reality, it’s your own money that you didn’t collect on your paycheques during the year. Think of it like an interest-free loan you made to the government, and now you’re finally getting your money back.
Although it may be tempting to use your tax refund for an online shopping spree, we at Ratehub.ca like to preach financial responsibility. Here are eight ways you can use your refund more wisely.
1. Pay off credit card debt
If you don’t pay off your balance in full every month, you’re carrying debt on your credit card. If that’s the case, using your tax refund to pay back some or all of your card’s balance is virtually a no brainer.
It all comes down to the hard numbers.
With most credit cards charging exorbitantly high interest rates of 19.99% annually, paying down your debt is almost like getting an instant and guaranteed 19.99% return on your money. For comparison’s sake, average 10-year stock market returns hover around 9.2% on an annualized basis.
According to the latest numbers from TransUnion, the average credit card balance in Canada is $3,661 – which roughly adds up to $60 in interest owed every month and $730 every year. If you were to receive the average tax refund of $1,788, you could pay off 48% of your balance and decrease interest payments by roughly half to $30 per month or $374 per year.
Aside from saving money on interest, using your tax refund to pay off your credit card debt has other benefits too.
It’ll lower your overall debt load relative to your card’s credit limit (aka your credit utilization ratio), which can help to give your three-digit credit score a boost. With a lump-sum payment, you can also get out of debt faster since you’re aggressively paying down a bulk of your credit card debt at once as opposed to gradually over time while interest continues to accrue.
2. Pay off other debts
If you owe money on other debts aside from credit cards, deciding where to put most of your tax refund will depend on a few factors.
First, you’ll want to identify your high interest debts (there isn’t a strict definition here but this generally encompasses loans with rates of at least 8% to 10%). Next, organize your debts in order of interest rate from lowest to highest, and focus your efforts on tackling the latter. For instance, if you have both a car loan with a 10% interest rate and credit card debt at 19.99%, you would want to put your tax refund towards the card’s balance as a lump sum payment.
What if you owe lower interest debts? Like, say, a line of credit with a 4% APR? Well, that generally depends on your financial goals and personality. Some argue you could invest your money instead of prioritizing paying off low-interest loans and come out ahead. Others believe in the merits of living a debt-free lifestyle – no matter the interest rate.
3. Start or increase your emergency fund
Whether or not you owe debt, you might be thinking about investing your tax refund. But before you do that, ask yourself: do you have any cash set aside for emergencies?
Without an emergency fund, you could be forced to go into debt or suddenly sell your investments if your car needs to be repaired, you forgot about a property tax bill that needs to be paid, or you lose your job. Many financial experts recommend you should have at least three months’ worth of living expenses saved, and if you don’t already have that set aside in a high interest savings account, a tax refund can help get you closer.
4. Pay for essentials
Whether it’s a long-overdue dentist appointment or a car repair, a tax refund can help you cover the cost of essentials you’ve postponed because of a cash crunch. You can also give your monthly budget some breathing room and just use your tax refund to pay for everyday bills like groceries.
5. Invest for your future
Don’t owe any high interest debts and already have savings set aside for emergencies? Why not invest the money from your tax refund for the long-term? You can opt for hands-off, simplified investing with a robo-advisor or do-it-yourself by buying individual stocks and ETFs with an online brokerage. Plus, if you invest in a registered TFSA or RRSP account, you can grow your money in a tax-efficient manner.
A TFSA allows you to grow your investments tax-free and offers flexible any-time withdrawals ideal for short-to-medium term financial goals. Meanwhile, an RRSP offers tax-deferment that benefit those in slightly higher-income brackets (earn over $50,000), imposes stricter withdrawal rules, and is primarily designed for retirement savings.
6. Save for a down payment
If you’re saving up a down payment to buy a home, a tax refund can feel like a drop in the bucket. But then again, every little bit helps.
If you plan on pulling the trigger on a home purchase in the near future, we’d recommend setting aside your down payment in something safe like a high interest savings account or GIC. As a first-time homebuyer, you can also borrow up to $35,000 from your RRSP to put towards the purchase with the Home Buyers’ Plan.
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7. Take courses or learn a new skill
As the old adage goes: education is the best investment.
With online courses available for almost everything – from learning how to code to how to become a better public speaker – paying for classes can be a great use of your tax refund. By equipping yourself with new skills, you could be in a far better position to make a career switch or snag that sought-after promotion.
8. Donate to charity
A 2020 Fraser Institute study found charitable giving is on the decline. Just 19.4% of Canadian tax filers gave to charity in 2018 (the latest year of available data). Canadians are also giving less money to charity. In 2018, we gave 0.54% of our total income to registered charities, compared to 0.59% in 2010 and a peak of 0.62% in 2008. The report also finds Canadians are less generous than our neighbours to the south (Americans donated 1.97% of their aggregate income to charity).
Making a charitable donation will not only help a cause you believe in, it’ll get you a tax deduction too.