What To Do With Your Tax Refund?
Written by Jim Yih •
Are you getting a tax refund this year? Our first inclination is typically that a tax refund is a bonus and we rush out to use it for something that gives us emotional gratification. Spending the bonus can make us feel good but there may be some smarter things to do with the money.
If you are interested in using the refund for building wealth, consider some of these options
1. Invest into RRSPs
Investing your refund back into RRSPs is just smart financial planning. It may not be as much fun as going out to buy that new toy, but investing money is a good habit and there may be no better time than right now. The current markets offer tremendous buying opportunities if you have a 2 to 5-year time horizon.
Aside from timing, investing now has advantages over waiting until January or February. It is forces you to save instead of having to find the funds from other sources in the future.
If you are investing in RRSPs early, you may want to apply for a reduction of taxes at source.
2. Pay off non-deductible debt
Paying off debt might be one of the best investments you can make particularly if that debt is non-deductible. For example, say you have a loan you are paying 7.5% interest. While you might perceive that to be a reasonable interest rate, think again. On an after tax basis, assuming you are in a 36% marginal tax rate, that interest is really costing you 11.7%. Unfortunately, when you earn a dollar, you must pay tax and therefore, you will only have 64 cents to go towards the interest.
The key to the debt reduction strategy is not to go back into debt. Far too often, I see people that commit to using their tax refund to pay off debts like credit cards or personal loans only to go back into debt. If this sounds like you, you might be better off investing your refund into RRSPs as a method of forced savings.
Getting a refund may not the best thing
While most of us would rather get a refund than have to pay any amount of tax at tax time, you may not be making the most efficient use of your money.
In fact, getting a refund really means you have given the government an interest free loan for 15 months. You would have been better off investing that money or using it for wealth building instead of lending it to the government tax-free. For some, tax refunds are a means of forced savings but if you are disciplined at financial management, you may want to apply for a reduction of taxes at source. This will force your employer to withhold less taxes off your paycheck so that this money is in your hands instead of the CCRA’s hands.
To apply to reduce tax deductions at source, you can fill out a form called the T1213 which can be found on the CCRA website at www.cra.gc.ca .
Simple not easy
Building wealth is really simple. Spend less than you earn and be sure to force yourself to ‘spend’ your money on assets that build wealth as opposed to assets that have no wealth. Unfortunately, while this is really simple, it is not easy to do because we get more emotional satisfaction out of using the money for things that either depreciate in value or have no financial value.
As you get that refund this year, think twice about what you want to do with that money. If you have already maximized the RRSP and have no debts, congratulations – spend away.