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Top 6 moves to make with your income tax refund

The new Canadian five and 10 dollar bills, made of polymer, are displayed with the previously released 20, 50 and 100 dollar notes following an unveiling ceremony at the Bank of Canada in Ottawa April 30, 2013. REUTERS/Chris Wattie

If you’re getting cash back this year from filing your income taxes, hold off on booking those plane tickets. There are ways to get the most bang for your refund bucks.

1. Redirect your refund into your Registered Retirement Savings Plan (RRSP)

“If you spend your RRSP refund … you unknowingly end up investing less than you started with, and less than most think,” says financial educator Talbot Stevens, author of The Smart Debt Coach. “If you spend your RRSP refund, you are converting dollars that have already been taxed into RRSP dollars that will be taxed again later when you withdraw the funds.

“Many people mistakenly think that if they put $3,000 in their RRSP and spend their refund, they’ve added $3,000 to their retirement fund,” he adds. “But if you’re in a 40 per cent tax bracket and spend the $1,200 refund, you’ve only invested $1,800 of the $3,000 you started with.”

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And if you reinvest that $1,200, you’ve already contributed $4,200.

2. Pay down debt

Attack those high-interest debts first.

“Credit cards and unsecured credit lines can charge interest ranging from 6 to 21 per cent and can be a real strain on cash flow, preventing you from getting ahead,” says Brad Mol, senior wealth advisor at TriDelta Financial.

Adds fee-for-service financial planner Stevan Dostanic, with Ottawa’s Astrolabe Financial Group: “With credit cards typically charging 19 to 21 per cent on unpaid balances, you are unlikely to find an investment that will guarantee you a higher return to justify investing rather than paying off debt.”

3. Put money toward your mortgage

This isn’t necessarily for everyone, but there are good reasons to consider making a lump-sum payment.

“Even though mortgage rates are very low, we know they will go up eventually,” says Jill Chambers, advisor at Calgary’s WealthCo Financial Advisory Services. “By putting a lump sum down on the mortgage now, the payments when you renew the mortgage may still be manageable. Going from 3 per cent to, say, a 6 per cent mortgage rate will still be a very reasonable rate. Remember, though, that it may almost double your mortgage payment.”

Of course, throwing money at your mortgage now will enable you to get rid of your largest debt faster.

“Using your tax return to pay down your mortgage will not only give you a guaranteed rate of return, but it will also ensure that you’re mortgage-free sooner and save you thousands in interest over the life of your mortgage,” Dostanic says.

Two factors can help you decide if this is the best use of your refund. Think about the rate of return and your own risk tolerance when it comes to investing.

“If you’ve renewed or taken a new mortgage in the last five years, you’re probably paying between 2.99 and 3.79 per cent,” Mol says. “In this case, it’s reasonable to expect that investing can out-perform the potential interest savings on paying down the mortgage. But there’s a caveat: if you’re only comfortable investing in GICs, which offer very little in returns currently, then your interest savings on paying down the mortgage is likely the better option.”

4. Open or contribute to a Tax-Free Savings Account (TFSA)

“If your income is currently below where you project it to be at retirement, you may want to look at maximizing your TFSA,” Mol says. “Similar to an RRSP, this account allows you to earn investment returns tax free. Although you receive no tax deductions, you are consequently not taxed on withdrawals.”

Not having any contribution room left for an RRSP is another argument for contributing toward a TFSA.

5. Get smart

If you have children, keep in mind just how costly their post-secondary education is going to be.

By catching up on RESP [Registered Education Savings Plan] contributions, you can receive up to a 20 per cent matching contribution from the Canadian Government in the form of a Canadian Education Savings Grant [CESG],” Dostanic says. “That’s an impressive rate of return on investment without taking any risk.”

Another option, Dostanic says, is to spend the funds on your own education as a means to improve your skill set and move up the ladder or transition to another career altogether. “This will pay off in the long run,” he says.

6. Look into life insurance

It can be hard for Millennial to see the benefits of this investment, but it’s worth remembering that anything can happen.

“Life insurance is essential, especially for young families,” Mol says. “You need to cover your debts and protect from loss of income to ensure the well-being of surviving family members.

“Even though life insurance can be inexpensive, some young families have a difficult time finding the cash flow to pay for it,” he adds. “Using a tax refund to fund the annual premiums can be a way to not affect day-to-day living expenses but still ensure you and your family are protected in the event of premature death.”