When you get a tax refund, whether it’s large or small, it’s really temping to splurge on something fun. Maybe a vacation – if you’ve survived winter, you might feel like you need some sunshine in your life. Or maybe it’s a new TV, the latest tech gadget, or a wardrobe refresh. But a tax refund is a fabulous opportunity to improve your current financial situation. And who couldn’t use a bit of that! So before you log into your favourite online shopping website, check out these smart ways to spend your income tax refund.
Better yet, these ideas are generally organized in order of priorities, so you don’t have to wonder which to do first if you check off more than one box. That is, paying the rent you still owe from last month (number 1 in this list) has a bigger financial impact than contributing to your retirement account (number 8). It’ll keep you from getting evicted! Spend that income tax refund wisely.
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1. Use your Income Tax Refund to Pay off Outstanding Bills
If you’re behind on your rent, car payment, cell phone bill, electricity bill, insurance, taxes, and so on – pay those first. Using your tax refund to buy the latest iPhone won’t help when your contract is cancelled for non-payment.
2. Pay off Credit Cards and Payday Loans
Next, pay off any credit card debt that you carry from month to month. Credit cards typically charge interest in the neighbourhood of 19-23% annually, so you don’t ever want to be paying that.
Related Post: The essential beginners’ guide to credit cards
Payday loans are even worse than credit cards, so pay them off in full. The rates are regulated by province, and range from a low of $15 in Alberta, BC, NB, and Ontario to a high of $25 in PEI, for a two-week loan of $100. That’s equivalent to an annual rate of 390% to 650%.
You could be paying up to 650% INTEREST on a payday loan!!!
That’s not a typo! If you borrow $100, and keep rolling it over every two weeks for a year, paying $25 each time, by the end of a year you will have paid $650 for a $100 loan.
And it can get worse!
If you get behind in payday loans, you may end up owing penalty fees to both your bank and the payday lender. Then, if you still can’t pay up, the payday lender may sell your loan to a collection agency which will drastically lower your credit score, and worse.
Find out your credit score and credit report for FREE with Borrowell. I’ve used it myself to track my own credit score.
3. Pay Down Other Debt
If you owe money for other things, like lines of credit, pay that off now too. These types of loans typically have higher interest rates than mortgages, but lower than credit cards.
You may choose to pay down part of your student loan, if the terms allow one-time extra payments. But this is a lower priority as long as you’re making the regular payments.
Once you’ve paid down your debts, let’s look at some other smart ways to spend your income tax refund wisely!
4. Buy Something you Need with your Tax Refund
Are your winter boots leaking water? Is your kitchen chair falling apart? This is a good time to buy those things you really need.
If you don’t have a dental plan through work or school or private insurance, make an appointment for that overdue cleaning. It’s not glamorous, but still money well spent.
5. Save for Upcoming Big Expenses
After that, look ahead to the rest of the year. What big expenses do you have coming up – Tuition? Buying a car? Vet bills? Moving? In this case, you should put that tax refund in a nice high-interest savings account. Your future self will thank you. For Canadians, I highly recommend EQ Bank.
EQ Bank has long been one of the industry leaders in high interest rate bank accounts, with a 2.45% everyday interest rate*!
But unlike some of the other online banks, with EQ Bank there are no limits or penalties for accessing your own money when you want it. You can get this everyday 2.45% interest rate* with the flexibility a chequing account for everyday banking such as paying bills and transferring money, without any hassles. Plus, transfer your money when you need to – with free Interac e-Transfers® and Electronic Fund Transfers.
Most importantly, you don’t want to take risks with this money, if you will need it in a few months. Investing in stocks, bonds, ETFs, mutual funds, or other risky assets is not the safest place for short-term savings.
Even if you don’t anticipate any big expenses later this year, it’s always a smart idea to set aside an “emergency fund” in a savings account like EQ Bank. This will give you a cushion in the event of job loss, computer blue screen of death, or other minor disaster.
EQ Bank legal footnote: *Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.
6. Medium Term Savings Goals
Are you dreaming of a big purchase in a few years? For example, home ownership, buying a car, world travel, starting a business? A smart option for Canadians is to open a TFSA – Tax-Free Savings Account. A TFSA is a type of account, where any interest, capital gains, or dividends are not taxed as income, unlike your regular savings account. But you can take out the money any time you wish, unlike an RRSP which in most cases is locked in until retirement.
Note that there is a limit to how much you can put in your TFSA each year – in 2020 it’s $6,000 – but if you haven’t maxed out your TFSA in previous years, you can catch up on those missed contributions.
My favourite place for Canadians to invest your money is Questrade, which offers you the choice of low-cost managed investing, or DIY investing with free ETF purchases. They are Canada’s fastest growing online brokerage. And with lower overhead costs than bricks-and-mortar brokerages, they can pass those savings on to you through lower fees. Questrade has a great online website to track your investment portfolio. Or trade on-the-go with the Questrade app.
Can’t decide between DIY investing to save money, or wanting a little advice to get started? My suggestion would be to start off with Questwealth for a year or two to get familiar with investing. When you’re feeling more confident, then switch to Questrade self-directed investing at that time. They would be more than happy to assist you with this.
7. Home Ownership
If you already own a house or condo, you could consider paying a lump sum down on the mortgage principal if the terms allow for that. But mortgages tend to be fairly low-cost borrowing, despite possible increases in interest rates. Financially, you’re probably better off doing something else with your tax refund.
If your home will need a big repair this year – or even next year, if it’s a major purchase – look back at #5 to see how to save for upcoming big expenses.
8. Contribute to your RRSP
RRSP is short for Registered Retirement Savings Plan. It means you don’t pay income tax now, but pay it when you withdraw those funds in retirement instead. RRSPs are great for those earning a high income now, and expect to be earning less in retirement.
Not sure which is better for your personal situation? Find out with my short quiz in RRSP vs TFSA: Which is Right for You?
9. Treat Yourself with your Tax Refund
And lastly, if you’ve taken care of the major bills and debt and increased your savings – go ahead and spend some of the tax return on yourself! It’s always nice to be pampered a bit now and then. Just don’t let your little splurge end up costing more than what you’re getting back.
Alternatively, treat someone else and donate to charity. Tip! You’ll get a charitable tax receipt that will increase next year’s tax refund.
Warning!!! Do NOT get an Instant Tax Refund!
This last bit of advice is critical! If you hire a company to prepare your tax return for you, they may offer you an instant tax refund on the spot. That is, you can walk out of the office with your money that day.
The Government of Canada caps the fees at 15% for the first $300 and 5% on the rest. This is an incredibly high rate of interest, given that when you file your return electronically, you generally have your refund within two weeks. On a $1,000 return, that’s $80 in fees – an 8% loan for 2 weeks, or over 200% annual rate of interest. Even if it takes a month to get your refund, it’s still equivalent to paying 96% interest annually.
If you haven’t prepared your taxes yet, I highly recommend TurboTax Canada. I have been preparing my own income taxes since I was a teen, and it’s never been easier than with software apps like Turbo Tax. Their step-by-step process walks you through entering all your information.
Now, let’s circle back to letting the government keep your money for a year. If this year looks similar to last year in terms of income and tax deductions, you can download the T1213 form from the Government of Canada website. Fill it out and return it to the government, and they will inform your employer to reduce your tax deductions.
A word of caution, though. Remember to use this extra income each payday wisely! And revisit this strategy if your finances change substantially, so that you don’t get hit with taxes owing next year.
Share this post, and let me know in the comments about YOUR smart way to spend your income tax refund!