Putting your tax refund to good use: Decrease what you owe or increase what you own
If you received a tax refund this year, I have a suggestion to make. Plan ahead with this money.
Remember, there are basically three types of things we spend our money on: no value expenses, such as food and clothes; expenses that lose their value over time, such as home entertainment systems and cars; and expenses that gain value over time, such as investments and real estate. If you received a sizeable tax refund, you have a choice. You can decrease what you owe or increase what you own.
Assuming, for the sake of argument, you decide to adopt one or both of the two alternatives, consider the following. Try to make a decision that will protect and increase your net worth, which is what you own minus what you owe. Your goal should be to increase your net worth every year. Your tax refund cheque, provided it is big enough, is ready to help you do just that. Consider the following options:
Pay Down Debt — This is important. If you have highinterest debts, reduce or get rid of them completely. Compare the rate of interest you are paying on your debt to what you are earning on your savings and investments. If you’re paying more interest than you’re earning, it makes sense to reduce that debt as quickly as possible. If so, pay off the most expensive debt (the one with the highest interest rate and that is not tax deductible) first. And if you decided to take an RSP loan, consider putting a payment against that loan to reduce your interest cost.
Mortgage Payment — Your home is, almost certainly, your single biggest asset, so it makes sense to retire your mortgage debt as quickly as possible. Depending on the terms and conditions of your mortgage, you may be able to make a lump-sum payment to reduce your mortgage and pay it off sooner. Seriously consider using some or all of your tax refund to do so.x
Tax-Free Growth — A Tax-Free Savings Account (TFSA) is a new way for residents of Canada to set money aside, tax-free, throughout their lifetimes. While contributions to a TFSA and the interest on money borrowed to invest in a TFSA are not tax deductible, the income generated in the TFSA is tax-free when it is withdrawn. The beauty of a TFSA is that it allows you to save for anything, whether it’s a major purchase like a car or vacation, or as part of your retirement strategy, on a taxfree basis. Subject to an annual contribution maximum, this new account is a great way to save.
Emergency Fund — It’s a great idea to have some cash available in case of an emergency or to meet unexpected expenses (new roof, auto accident, or in the event of a job loss). The rule of thumb is to try to set aside an amount equal to 3 – 6 months’ pay. Consider keeping this money in a liquid money market mutual fund to earn competitive rates of return. It’s always available when you need it.
Education Savings — Contributing to a Registered Education Savings Plan (RESP) for your children can go a long way towards paying for a post-secondary education. The Federal Government will top-up your annual contribution by 20%, subject to certain conditions.
RSP — Avoid the rush of next year’s RSP contribution deadline. Get a head start by taking your refund and putting it directly into your RSP and your money will start working for you sooner.
These are just a few of the options available to you and your potential tax refund. If you feel that you need help to tackle this process, the answer’s really quite simple. Start a conversation with a Certified Financial Planner (CPF) about your long-term financial goals. It is never too soon to put a wealth building strategy in place.