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Spending your refund is the most fun option of all, but it won’t leave you as well off financially. (George Doyle/Getty Images)
Spending your refund is the most fun option of all, but it won’t leave you as well off financially. (George Doyle/Getty Images)

Tax Matters

Ten smart ways to make the most of your tax refund Add to ...

If you filed your taxes on time, you might be familiar with the new Canada Revenue Agency tax form. “Line 1” reads: Total income. “Line 2” says: Send it in.

Kidding. The forms haven’t been simplified quite that much.

Now, if you sent more to the taxman during 2012 than you should have, you might be expecting a tax refund some time soon. A friend once told me that getting a tax refund made him feel as though he had been shot at, and missed. It’s a relief for some.

So, what are you going to do with your tax refund this year? There is no shortage of ideas. Here are 10 smart ways to use that refund:

1. Pay down debt

Some types of debt are good, some are bad. Pay down your bad debt, which is generally debt with a high rate of interest and where that interest is not deductible for tax purposes. Good debt is that which allows you to purchase assets growing in value, where the interest rate is low (and even better if the interest can be deducted). Paying down bad debt will provide an after-tax rate of return equal to your rate of interest on that debt. Not a bad rate of return today.

2. Contribute to your RRSP

If you haven’t saved enough for retirement yet, this option is a very good one. Assuming you have room to contribute to your registered retirement savings plan, then a contribution will provide yet further tax savings when you claim that deduction in the future.

3. Contribute to a TFSA

If you’re over 18 and a Canadian resident, you should have a tax-free savings account. It provides the ability to shelter from tax the growth and income on various investments. What’s not to like? I’ve talked in the past about whether to use an RRSP or TFSA for savings; both have merits (read a previous column here).

4. Buy life insurance

Too many Canadians are underinsured. If you were to die unexpectedly, would those who depend on you still be able to make ends meet financially? But life insurance isn’t just about protection, it’s also about tax-sheltered accumulation and other benefits. See my article here for several uses of life insurance.

5. Contribute to an RESP

The costs of a postsecondary education are significant. Contributions to a registered education savings plan (RESP) can also trigger Canada Education Savings Grants (CESGs) from the government, which help too. Setting aside $2,500 per year per child will attract the maximum grants and can go a long way to paying for that education.

6. Donate to charity

You can do good and save more tax at the same time by donating your refund to charity. If you haven’t donated before, or not since 2007, you’ll be entitled to the new enhanced donation tax credit introduced in the 2013 federal budget (it’s an additional 25 per cent in tax savings federally on your first $1,000 of donations).

7. Lend the money

If your spouse is in a lower tax bracket, then shifting income to your spouse could save you tax dollars. You can do this by lending money to your spouse and charging the prescribed rate of interest (currently 1 per cent; you can lock in this rate indefinitely).

Any income earned on those funds by your spouse will be taxed in his or her hands – not yours. Your spouse will have to pay you the interest each year by Jan. 30 (for the prior year’s interest charge), and can deduct that interest.

8. Help your heirs

You can help your heirs with your tax refund by giving the money to them to help with debts, buying a home, or simply to give them more to invest. Removing this money from your wallet and giving it to your heirs will also reduce the size of your estate, which will save taxes and probate fees upon your death. You can also lend the money to your heirs, taking back a mortgage on your heirs’ home as a way to protect your loan and potentially the home from other creditors.

9. Invest in your home

If you use your refund to improve the value of your principal residence through renovations or improvements, you’ll shelter that added value and its growth from tax, thanks to the principal residence exemption. A cottage can also count as a principal residence.

10. Spend the cash

This strategy may be the most fun of all, although it might not leave you as well off financially as the ideas above.

Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books. tcestnick@waterstreet.ca

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