by Scott Hannah
Q: My partner and I usually don’t get tax refunds. However, last year we made a big effort to contribute to our RRSPs, despite me starting maternity leave part way through the year. We were pretty happy to find out when we filed our taxes that we will each be getting decent refunds. We want to get the most out of our refunds, so should we save, pay down our debts, or spend the money on the baby? ~Vanessa
A: Getting a tax refund, especially if it’s the first time in a long time, always feels great. For some, it feels like a reward for all their hard work the previous year; for others, it feels like free money. Many people also see it as an opportunity to splurge. While a splurge could certainly be part of it, the best way to get the most out of your tax refund is to plan how to use it in a way that helps you work towards your financial goals.
From saving to spending, investing or paying off debts, tax refunds can be important tools. The right way for someone to use their tax refund depends on their overall financial situation. Here are some tips to consider as you plan ahead:
Paying Off Debt Might Be a Bigger Deal Than You Think
When faced with earning less interest in an investment than what you’re paying on your credit cards or other debts, it might seem logical to put the refund towards paying off your debts. To help you decide if this would be a good decision for your household or not, think about your priorities. Paying off the highest interest debt will save you money (less interest/fees over time); paying off the lowest balance first can free up money in your budget for day-to-day expenses (one less payment each month).
There are many good debt repayment strategies, so it really depends on your situation. As first time parents, depending on your level of household income you will also likely qualify for payments through the Canada child tax benefit program. These would start in July because you filed your taxes before the April 30th deadline. The funds will give you a little more each month to spend on essentials, so freeing up cash flow with debt repayment might not be your biggest consideration if all you need is a few hundred extra dollars each month.
Saving is Much Harder When You Have Debt
When you’re in debt, saving is much harder to do. The bills always seem to come first. However, if your priority is to get out of debt, it’s wise to use at least part of your income tax refund to start a small savings account to help you deal with unexpected expenses. That way you won’t need to rely on your credit cards when faced with a financial emergency.
Regardless of which life stage you are at, the one constant is change. Many first-time parents hope that their cash flow will improve once maternity / paternity leave is over. Their cash flow will certainly change, but if you will need to add child care expenses to your budget, the change may not be as positive as you’d hoped.
One way to try and plan for the changes and/or challenges you may face, regardless of your current life stage or situation, is to use an interactive budget planning calculator, or a series of financial calculators, that let you manipulate the numbers to talk about “what if” situations. That way you and your partner can have an informed, guided discussion that lets you plan in a positive way.
Balance Might Just Be Your Best Bet – Consider All of Your Options
Most people have many more options of what to do with their money than they realize, so creating a balanced approach might just be your best solution. For instance, if your goal is to pay off a credit card in 12 months, by paying it off in 18 months, you would have some money left over to contribute to your RRSP. This could generate a refund next year that would allow you to make a lump sum payment to that credit card, another debt or top up your emergency savings account. The 6 months of additional interest you’d pay on your credit card’s declining balance would likely be offset by the increase in value of your RRSP.
Another aspect of a balanced approach could be asking your employer to reduce your monthly taxable income to reflect ongoing RRSP contributions. This will likely not generate much of a refund next year, however it will add a little to each pay cheque between now and then. This bump to your cash flow might allow you to free up the money you need to fund a splurge or invest in an RESP (Registered Education Savings Plan) for your new addition.
Your child’s post-secondary education costs might be the furthest thing from your minds right now, but the federal government will provide a grant equal to 20 percent of the funds contributed to an RESP to a maximum of $500 each year. On your first $2,500 contributed each year, that’s almost like getting a 20 percent return.
The Bottom Line on Getting the Most Out of Your Tax Refund
The best way to get the most out of your tax refund is to consider what’s important to you and then get creative with your options and solutions. It’s easy to lose sight of the fact that an income tax refund is not free money, so avoid spending it before you’ve got it. In reality, it is money you’ve worked hard to earn. To get the most out of it – create a plan that lets you do what’s most important to you and helps you work towards the long term financial well-being of you and your growing family.
- What is a Debt Consolidation Loan and How Does it Work?
- The Benefits of Filing Your Tax Return in Canada
- Use a Tax Refund to Jump Start a Savings Account