What is a Good Use of your Tax Refund?

Couple discussing their finances

It’s tax season and after completing your taxes, you may be entitled to a tax refund. “A tax refund generally happens because you’ve had too much tax deducted from your income during the year, or from taking advantage of programs such as RRSPs to reduce your taxable income, resulting in a tax refund,” says Leslie Hanson, Wealth & Retirement Advisor at Cambrian Credit Union.

While using a large refund to buy a new gadget or pay for a vacation is always tempting, Hanson recommends a few different strategies, depending on your circumstances:

Make a contribution to your savings

“By turning around and making another contribution to your RRSP, you are reducing your taxable income for the next year,” she says. It’s important to save for your retirement, even if you have a pension at work, because your pension is never your full salary.

Hanson also suggests making a contribution to your TFSA, or contributing to an emergency fund if you do not yet have 3 – 6 months’ of expenses saved.

Pay off high interest debt

“Another good use of your tax refund is using it to pay off high interest debt, such as credit card debt,” Hanson says. This will reduce the amount of interest you will be paying on that debt, getting you debt-free sooner.

But think twice before using the refund to pay off lower interest debt such as a mortgage, especially if you don’t have a lot of money saved for your retirement. “You are far better off saving that money for your future, either in a TFSA or RRSP,” Hanson says. “I always say, when you’re retired you can’t take a brick off your house to buy groceries, so you have to make sure you have some savings to draw on once you’re retired.”

Save for your children’s education

Contributing to an RESP allows you to benefit from a 20 per cent grant from the government for the first $2,500 of your annual RESP contribution. “If somebody is willing to give you free money, then you should definitely be taking advantage of that,” Hanson says.

Keep in mind that, while a large tax refund may feel nice to receive every year, the ideal tax situation is actually not to get a refund. “A zero tax refund is what everyone should be striving for. If you get a refund, it means that you were pre-paying the government when you don’t need to be,” Hanson says. She recommends reducing the amount of tax held at your work place if you’re over-contributing, and continuing to save that extra money or put it towards your high interest debt, as you are used to living without that income anyway.