Are you one of the millions of Canadians set to receive a tax refund this year? Here are some ideas of what to do with those funds.
The good news is that you’ve prepared your tax return and realize that you’re entitled to a refund. This certainly beats the alternative of owing the government money. If you do find yourself in the position of receiving a tax refund, here are six things to consider doing with that money.
1. Splurge
In general, the suggestion to treat yourself comes last on the list of things to do with your refund, if it shows up on the list at all. But if your refund is relatively small, consider treating yourself to something you’ve been eyeing or doing something special, such as going out for a nice meal. Even if you receive a larger return, it is acceptable to take a percentage of it and use it to enjoy yourself.
2. Contribute to your RRSP
You might consider a contribution to your RRSP to build up your retirement nest egg. If you have an RRSP, you may have carryover contributions from previous years when you didn’t fully fund your account up to your yearly limit. Taking all or part of your refund and contributing it to your RRSP can help use up some or all your available contribution room and get you one step closer to your retirement savings goals.
You may also receive a potential tax break for the 2022-2023 year since these contributions are made on a pre-tax basis and the funds are only taxed upon withdrawal.
If appropriate for your situation, you might also consider contributing to a spousal RRSP account. This is an income-splitting strategy for couples that can help decrease their collective tax burden.
3. Contribute to your TFSA
Placing your tax refund money into your TFSA to save for a major purchase can be another option to consider.
Contributions to a TFSA do not provide an upfront tax deduction. However, your refund can be placed in a range of income-generating investments, which will grow tax-free inside your account. The advantage is that you can save towards a big goal, such as your first home or a long vacation, and any funds withdrawn are not subject to taxes.
This can offer an advantage in your tax planning in retirement. It is also a way to diversify the taxation of your retirement income sources if you also have an RRSP and have already maxed out your available contribution room.
4. Invest via a taxable account
While the tax advantages of an RRSP or a TFSA are very tempting, investing in a taxable brokerage account also has its advantages. Capital gains are taxed at a favorable rate, so it can make sense to hold investments that are likely to generate sizable capital gains in these accounts while holding income generating investments in an RRSP or TFSA.
Dividends collected on stocks in a taxable brokerage account are also taxed preferentially as opposed to some other income sources. This is because the company has already paid tax on these dividends, and the government does not tax this income again.
Another thing to keep in mind is that funds in a taxable account like an RRSP can be more readily accessible over time than funds held in a tax-sheltered account since they are not subject to the same rules.
5. Pay down debt
If you have outstanding debt such as high interest credit card payments, a personal loan or a mortgage you can consider putting some or all your tax refund towards reducing this debt. You can eliminate or at least reduce the overall amount of the payments on this debt, saving the compounded interest cost over time.
In the case of a mortgage, if the refund is sizable, you could consider making a substantial payment to reduce or eliminate this debt entirely.
There is currently a suspension on the accumulation of interest on student loan debt by the Government of Canada until March 31, 2023. This can be an excellent time to pay off some or all of this debt with your tax refund. Besides reducing your debt, making a payment now can help eliminate additional interest once things return to normal and this suspension is removed.
6. Contribute to an emergency fund
Your refund money can be used to start or add to an existing emergency fund. This is money that is generally held in a liquid, interest-bearing account to be available for an emergency. This might be the loss of a job or a large, unexpected repair that is needed on your home or car.
A rule of thumb says that you should have at least six months worth of your required and necessary expenses in this fund. This should include money to cover payments such as rent or a mortgage, food, a car payment and other expenses that are essential to maintain your regular standard of living. This could also include extras like entertainment, dining out or other discretionary spending although it remains important to prioritize your necessities and those of your dependents.
Review your withholding tax
While not something you would do with the funds from a tax refund, this is a good time to review your withholding tax for the current year to see if it best reflects your situation. Has your income level changed? If so, are you having enough withheld?
Withholding tax refers to the amount of income tax your employer withholds from your paycheck and typically does not consider various deductions normally claimed, such as RRSP contributions, which reduce your taxes payable. If you find yourself getting a sizable refund each year you might consider reducing your withholding tax, so you receive more money with each paycheck.
The takeaway… Prioritize what’s important to you
Getting a hefty refund can be a form of forced saving, but you are not receiving any interest on this money. You could be putting it to better use during the year by investing it. However, it really depends on your current situation and your needs.
Give us a call at 514-934-0586 (Montreal) or 403-228-2378 (Calgary) to discuss the best way to put your tax refund to use and to do a review of your withholding tax to ensure that it is optimal for your situation.
While this article been carefully checked, we cannot and do not guarantee that the information provided is correct, accurate or current. Please speak to your Rothenberg Wealth Management advisor for advice based on your unique circumstances. Rothenberg Capital Management is a member of IIROC and the Canadian Investor Protection Fund.
