Filing a tax return can often feel like navigating through a maze of complexity and frustration. The process involves sifting through a myriad of forms and documents which can be time-consuming. At least there is one nice thing about doing your taxes: getting a refund. Many Canadians expect a tax refund and in 2021, over 12 million tax returns resulted in a tax refund.
Receiving a tax refund can be tempting to imagine spending it on a trip or something fun – we get it! But it may also be a good opportunity to use some or all of it to improve your financial well-being.
We discuss the best strategies to help you use your tax refund wisely for your financial future.
Reduce non-deductible debt
Debt with a high interest rate such as credit card debt, a personal car loan, or line of credit are debts that should be paid down quickly. When you receive your refund, prioritize paying off the debt with the highest interest rate first. Interest on personal loans is not deductible for income tax purposes and you're paying interest on the loan with after tax dollars. The higher the interest rate, the more income you must earn to pay the interest on the loan.
Emergency fund
A cornerstone of financial planning is to set aside funds for unexpected expenses. The rule of thumb is to have three to six months’ worth of living expenses in a liquid account. Being financially ready for an emergency can be a big stress relief.
With the current interest rate environment, having funds sit in a high interest savings account is much more attractive with rates paying almost 5%.
Save for retirement and other financial goals
Allocating your tax refund towards your retirement is an excellent strategy for securing your financial future. The more money you are able to set aside now, the more flexibility you will have when planning your retirement.
Contributing to an RRSP reduces your taxes for next year, potentially boosting your refund, while also allowing your investments to grow tax-free until retirement, when withdrawals are taxed.
Contribute to a TFSA
The TFSA is an additional option for investing your tax refund. While contributions are not deducted from income, all growth, income, and withdrawals are tax-free. You can also gift money to your spouse to invest in a TFSA.
Save for your kids’ future
If you have children, consider contributing to their RESP. The first $2,500 of contribution generates a 20% grant from the government of $500.
The cost of university is rising, and a four-year degree now costs upwards of $100,000.
Receive your tax refund earlier
If your personal or family situation has changes since last year, you may be entitled to claim credits you haven’t claimed before, such as the pension income tax credit, spouse or common-law partner amount, caregiver amount and disability amount. By advising your employer, this may lower your tax deductions at source.
If you have regular tax deductions such as RRSP contributions, childcare expenses, and deductible support payments, speak to your accountant about making a request to CRA to reduce your tax deductions at source. If CRA approves your request, your employer will be able to reduce the income tax withheld from your pay during the year, which will increase your net pay. This means you will have more funds in your pocket throughout the year.
There are several ways to use your tax refund and your choice will depend upon your priorities and personal financial situation. Consider what matters most to you and obtain professional advice from Finucci Janitis Allen Wealth if you have questions about your options.
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