Strategies to optimize the use of your income tax refund

 

As a result of RRSP contributions, interest expenses, tax shelter deductions or various other tax deductions and credits, you may be expecting, or have recently received, an income tax refund from the Canada Revenue Agency (CRA). If you receive a tax refund, it may be a good opportunity to determine if you can use some or all of it to improve your financial well-being. This article discusses some strategies that may help you use your income tax refund wisely and assist you in meeting your financial goals.

 

Saving for your future

 

You may be tempted to spend your refund on things like a well-deserved vacation or doing a minor renovation to your home. In some cases, this is an appropriate use of the money, depending on your need at the time. You might also consider saving all or a portion of your refund for your future financial security. The “compounding” effect helps even small savings grow significantly over the long term, helping you achieve the financial lifestyle you want.

 

Education savings

 

If you plan to help your children or grandchildren with their education costs, you may want to use your income tax refund to contribute to a Registered Education Savings Plan (RESP). Keep in mind that the first $2,500 of RESP contributions attracts a federal government grant of $500 to $600, depending on your family income. If you haven’t opened an RESP for your children, you may wish to use your tax refund to start making contributions.

 

Reduce non-deductible debt

 

Consider paying down an outstanding non-deductible debt that’s subject to a high interest rate. Non-deductible debt includes: credit card debt, a personal-use car loan, a line of credit used for personal purposes or the mortgage on your home. As the interest on a loan used for personal purposes is not deductible for income tax purposes, you’re paying the interest on the loan with after-tax dollars. The higher the interest rate on the loan or the higher your marginal tax rate, the more income you’ll have to earn to pay the interest on this loan. This makes it more beneficial to pay down this debt.

 

RRSP or non-registered savings

 

If you don’t have high interest non-deductible debt, another option is to save your income tax refund in an RRSP or a non-registered account. Whether you should save your refund in an RRSP or a non-registered account depends on your specific circumstances and several financial assumptions. Here’s some general guidance that may help with this decision:

 

· If you expect your marginal tax rate in retirement to be the same or lower than your marginal tax rate today, consider contributing to your RRSP;

 

· If you want to invest in securities that produce Canadian source dividends and capital gains and you’re in a low tax bracket today but expect to be in a

  higher tax bracket in retirement, you’re generally better off saving outside an RRSP.

 

 

Contribute to a Tax-Free Savings Account (TFSA)

 

The TFSA provides a further option for investing your tax refund. The TFSA allows you to make a $6,000 (for 2019) annual maximum contribution. All growth, income and withdrawals are tax-free. You can also gift money to your spouse to invest in a TFSA without being subject to the income attribution rules. Should you invest your tax refund in an RRSP or a TFSA, if you’re unable to do both? The following general guidelines may help you make the decision:

 

· Choose the TFSA if your expected marginal tax rate in retirement is going to be higher than your marginal tax rate today.

 

· Choose the RRSP if your expected marginal tax rate in retirement is going to be lower than your marginal tax rate today.

 

Emergency fund

 

A fundamental financial planning strategy is to set aside some money or unexpected expenses or a job loss. In general, consider keeping approximately three to six months’ worth of living expenses within a liquid emergency fund. If you don’t have an adequate emergency fund, you may want to direct some or all of your tax refund towards creating one.

If you don’t want to direct your income tax refund to a savings vehicle that may earn little interest, consider obtaining or increasing your line of credit for emergency purposes only.

 

Conclusion

 

There are numerous ways you may choose to use a tax refund. Your choice will depend upon your priorities and your personal financial situation. You can use your refund for many purposes including: saving for education or retirement, reducing non-deductible debt, building an emergency fund or simply for fun and relaxation. Whatever you decide, consider what matters most to you and obtain professional advice if you have questions about your options.