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Tax Matters

10 ideas on what to do with your tax refund this year Add to ...

This week I put on a jacket that I haven’t worn for quite a while, and when I reached into the pocket I found a $20 bill. What a great feeling. You gotta love found money.

A tax refund is a lot like that. If you’re getting a refund, the money was always yours, but you’re now being reacquainted with those dollars – and I know it feels pretty good. Setting aside the fact that you were actually lending the government your hard earned money, free of charge, have you given thought to what you’re going to do with your tax refund this year? Consider these 10 possibilities.

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1. Pay down bad debt. Bad debt is that incurred for personal consumption and where the interest rate is high (credit card debt is the most common). Paying down your bad debt with a tax refund provides a guaranteed, after-tax, rate of return equal to your interest rate on the debt. You’ll be hard-pressed to find a better return than this elsewhere.

2. Contribute to your RRSP. If you have room to contribute to your registered retirement savings plan, then your tax refund can provide cash for this purpose, which will result in additional tax savings for the deduction you’ll claim in the future. Next to paying down bad debt, setting aside money for retirement is your next best option if you haven’t set aside enough yet.

3. Contribute to your TFSA. I won’t debate the merits of contributing to a tax-free savings account over an RRSP since I’ve done that already. Suffice it to say that every Canadian over 18 should have a TFSA and a tax refund can provide cash to make investments in this tax-sheltered account.

4. Invest in alternatives. Whether you have enough set aside for your retirement or not, investing your tax refund is a prudent option. So, how should you invest those dollars? Consider “alternative” strategies. I’m talking about investments that are not particularly correlated to equity markets. “Alternatives” can include real estate, private business ownership, and strategies offered by money managers that are not simply long-only investments in stocks.

5. Invest in life insurance. There are many reasons to buy life insurance. Reasons include: Providing for dependants, covering taxes on death, paying off debts, equalizing an estate, or creating a tax-sheltered investment portfolio, among others. A tax refund can help to cover the cost of premiums on a policy.

6. Contribute to an RESP. Setting aside money for the education of a child or grandchild is a great use of your tax refund. These contributions can attract Canada Education Savings Grants (CESGs) from the government. Setting aside, say, $2,500 annually for a child can go a long way to paying for a post-secondary education and will attract the maximum in CESGs.

7. Donate to charity. Why not use your tax refund to not only create more tax savings, but help others at the same time? And if you insist on using your refund for other things, consider using just a portion of your refund to make donations. If you do this every year your philanthropy can become much more strategic, impactful and meaningful.

8. Lend the money. Consider lending your tax refund to your lower-income spouse for him or her to invest. If you charge the prescribed rate of interest on the loan (currently 1 per cent; a rate which can be locked-in indefinitely) then all income earned by your spouse will be taxable in his or her hands – otherwise known as income splitting. You might also lend the money to help your child buy a home, or start a business.

9. Give to your heirs. Making a gift to your heirs today can allow you to reduce the size of your estate at the time of your death, reducing taxes and probate fees at that time. It can also provide you with the opportunity to see that gift enjoyed by, or put to good use by, your heirs. Your tax refund can provide the cash for a gift this year.

10. Spend the money. When it comes to a tax refund, many people like this option most of all. Spending your tax refund may be just fine in situations where you have no bad debt and your retirement savings are in good shape.

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