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What should you do with your tax refund?

What should you do with your tax refund?

The end of April approaches and with it the end of tax season, a stressful time for many Canadians. Most people just want to forget about their taxes once they’re filed, but when that tax return comes through it can be a reminder of financial decisions you made over the past year.

Once you have that return in your hand, what will you do with it? Sure, you could blow it all on a vacation or a new bike, but maybe putting it towards a savings vehicle is a wiser choice.

Dennis Tew, Head of Business Strategy at Franklin Templeton Investments, says there are good financial habits you can build when you get your tax return, but first you should be questioning why you’re getting a return at all.

“First of all, people shouldn’t be getting tax refunds,” he says. “All that means is the government had your money when [should] you have it, so if people are regularly getting tax refunds that’s the first thing they should look at. People that are making regular RSP contributions, or have regular child care expenses, or medical expenses, or make big donations they can actually get, whatever’s causing them to get a big refund, they can get that reduced at the source, so that they’ve got access to that money all year. That’s probably first and foremost, big refunds don’t necessarily mean good things.”

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That said, Tew understands that it’s nice to get a lump sum because you may be able to do something valuable with it that you wouldn’t normally do if it were spread out over the year.

Get the debt down

Tew advises people should look towards taking care of debt first and then put the remainder of the tax return into a savings vehicle such as an RSP or TFSA.

“The first thing I would look at is debt, what kind of debt am I carrying? What type of debt?” He says about using that tax return wisely. “Something truly high interest like credit card debt is likely something you want to address up front. Whereas if you don’t have debt, or only have a low interest rate mortgage then maybe you would start looking at some of those savings options.”

When it comes to savings, Tew is all about the importance of the RSP and how using that extra lump sum to max out your contributions can come back to you in good ways.

“I personally really like the RSP contribution for the majority of Canadians to put some money away that will grow tax free,” he says. “Get that up-front tax deduction that will actually get more money in your hand. And that extra money again can pay down debt. Make a TFSA contribution and things like that, again, it just give you more money. The areas where that doesn’t work so well is maybe if you’re later in life or you’re not paying much tax now, so making a RSP contribution isn’t going to give you that much of a big refund. That’s where it gets a bit personal.”

Tew suggests people use different savings vehicles depending on where they are in life. Although an RSP contribution is always a good choice, he says depending on your age it can become a question of whether it’s the best choice. He recommends people who are later in life max out their TFSA contributions and younger people should focus on their RSP.

Balance fun with responsibility

“If the choice is save for retirement or blow it today, you’re only going to hear me say save for retirement, especially if you’re young. I know it sucks, but maybe do an 80/20. You save 80 per cent of it and spend 20 per cent of it. But the younger you are it’s only going to be to your benefit for the rest of your life. People that start saving in those last 10 years of retirement are a lot worse off than those who saved a good chunk of everything they earned all the way through. It’s just a much more pleasant ride.”

Tew thinks the complexity of dealing with taxes scares people and that improving everyone’s education on the types of deductions Canadians can benefit from would go a long way.

“There are so many different kinds of tax credits and deductions that are available,” he says. “A five or ten minute interview with a tax preparer can reveal you may be missing something that could be beneficial to you… We’ve got three really good, four if you count the disability plan, tax deferred savings vehicles in Canada: RSP, TFSA, disability savings plan, and RESP. I would encourage everyone, to the extent they can, to max out all of those. The earlier you start the easier it becomes.”