It’s that time of the year! Byebye tax return, hello tax refund!
If you’ve already filed your taxes (what a boss!), your refund should be well on its way!
Depending on how you filed your taxes (digitally or on paper), you could be expecting a sweet refund within 2 to 8 weeks (assuming CRA has already received your tax return).
You might get it faster if you have signed up for direct deposit with CRA.
Is there a better feeling than knowing that a big-ish amount of money is arriving soon?
Not to the 27-year-old me who received her tax refund cheque with dollar signs sparkling in her eyes, already brainstorming ways to spend it.
I don’t remember how I ended up spending that CA$1,700. Chances are, I probably treated myself to a CA$5 smoothie, bought a CA$50 dress, and saved the rest in my chequing account to be spent slowly over time.
Not the worst thing to do in the world, but far from the best.
The present-day me is older and wiser (but mostly older), and has a much better handle on tax refunds.
For anyone that feels a bit financially behind and wants to play catch-up this time of the year, having your tax refund at your disposal can make a world of difference.
For anyone feeling financially behind, getting your tax refund gives you a little breathing room and allows you to play catch-up with your bills and saving goals.
I have mapped out the exact steps to maximize the use of your tax refund to the fullest extent.
Step #1: Pay down your consumer debt
A credit card is a hella expensive way to borrow money.
Most popular credit cards come with interest rates in the 20% to 30% range, on top of annual fees, which is crazy when you compare it to other types of borrowing such as mortgage (roughly 1%-5%), student loans (roughly 2%-5%) and lines of credit (roughly 5%-10%).
Because of that, it’s all too easy to fall into a debt spiral that people struggle to get out of. And, of course, we want to avoid that.
That’s where tax refunds come in. You could either pay off your credit card debt completely, or at least make a sizable dent with your tax refund. The latter will lower the amount of interest you’ll have to pay down the road.
Once credit card debts are out of the way, direct whatever is left in your tax refund towards other high-interest debts (with 5% interest rates or higher).
Step #2: Save for retirement
Once you’ve tackled your debt (or that you were debt-free to begin with), it’s time to leverage those tax-sheltered accounts and boost your retirement savings!
Your mileage may vary, but in most cases, you can’t go wrong with putting a significant chunk of the remaining tax refund into your RRSP, TFSA, or both.
In an ideal world, we’d all be maximizing our TFSA and RRSP contributions every single year, but in reality, most of us have to prioritize one over the other.
TFSA vs. RRSP, which is better?
Their respective merits have been debated endlessly online and in personal finance books.
Generally speaking, the higher your household income, the more you’d want to prioritize contributing towards RRSP over TFSA for the short-term tax benefits.
The higher your income, the more you should prioritize contributing towards RRSP over TFSA.
Besides that, it really depends on each person or couple’s particular circumstances and preferences, so your financial advisor would be in a better position to lay out a more detailed plan.
Regardless, putting your tax refund into either RRSP or TFSA would be better than spending it.
Step #3: Top up your emergency fund
An emergency fund (or a rainy day fund) is money set aside for emergencies like job loss, medical emergencies, and surprise bills. It should cover at least 3 to 6 months’ worth of your living expenses.
As a self-employed freelancer, I can definitely vouch for the necessity of having an emergency fund. Without it, I would never feel financially secure.
Don’t worry if you don’t have an emergency fund yet. It’s not too late to build one up once your refund deposit arrives.
If you already have an emergency fund, but depleted it for whatever reason (no need to feel guilty over it, that’s what it’s intended for), you have an opportunity to top it off with your tax refund.
Step #4: Make extra mortgage payments
If you’re currently mortgage-free, feel free to skip to the next step.
The average Canadian mortgage is just shy of CA$200,000.
Some people aren’t rushing to pay off their mortgage because they have low mortgage rates or other financial priorities. For others, the thought of carrying any amount of debt induces a cold sweat. But no matter where you sit on the mortgage love/hate scale, you’d rather see it go away.
My husband and I are only 2 years into our 30-year mortgage, and we’re paying an enormous amount of interest right now. If we want to build equity faster and pay less interest during the life of the loan, we’d have to make extra payments.
That’s precisely the reason I would recommend you to consider using your refund to pay extra toward your mortgage principal. You’ll feel so much happier getting rid of the mortgage burden sooner!
Step #5: Save for something big
By now, you’ve paid off your consumer debt, made significant headway on retirement savings, whipped your emergency fund into shape, and even made extra mortgage payments if you own a place.
With whatever tax refund money you have left at this point, you could start saving toward a large expense like a trip, a kitchen renovation, a new degree, or even a car.
You might want to park all your non-retirement savings in a high-interest savings account that offers unlimited transactions. That way, you don’t have to worry about market fluctuations negatively impacting your short-term saving goals.
Notice that I purposely put this step as the last one to ensure that you’ve covered all your financial bases before any type of spending comes into the picture.
If you’ve followed the steps above, congratulations!
Don’t forget to pat yourself on the back for a job well done.
I usually like to give myself a small reward (like a CA$5 bubble tea) whenever I’ve completed a dreaded task, so that I’d be more inclined to repeat the desired behavior in the future.
I know it sounds crazy for a personal finance blogger to advocate for spending money, but seriously, you deserve a small prize for handling your tax refund smartly. And don’t let anyone guilt-trip you into thinking otherwise.