Many people dread the annual tax season because collecting the required documents and completing all the calculations can seem overwhelming. After finalizing their tax return some may be happy to discover they will receive a refund. It may be tempting to think of a tax refund as ‘found money’ that can be spent on something to treat yourself – but is this the best strategy?
Sitting back and examining how a tax refund happens might change our thinking about what to do with it. Typically, there are two main reasons tax refunds come about:
- Too much tax being deducted at source from our taxable income. There may have been a miscalculation on income tax owing throughout the year or perhaps you received a significant bonus which triggered an abnormally higher tax payment than what is your true average tax rate.
- Strategic financial actions taken to reduce income tax, including:
- Making an RRSP contribution to reduce taxable income and in turn reduce income tax owing.
- Using tax credits such as charitable donations, post-secondary tuition/education or employment credits for home office expenses – which are deducted from taxes owing (instead of being a deduction on income before taxes).
Three ways to put your tax refund to work
- Save – Having a savings plan in place will help with unexpected expenses such as car and home repairs or in the event of a job loss or injury that leaves you unable to work. Disability and employment insurance typically cover a percentage of your gross income and are unlikely to provide 100% of your total income. Do you have enough to cover fixed expenses like mortgage or rent, utilities, insurance and food? Having cash savings can be a huge stress reliever and may mean you won’t have to rely on borrowing money or using high interest credit cards to cover your bills.
- Pay down debt – Start with high interest loans such as credit cards, lines of credits, student loans or car loans. Payments will be applied directly to the principle amount owing and result in reducing the amount of interest charged and easing debt load. Reducing debt will improve your cash flow and perhaps allow for investment savings to improve your financial future.
- Invest – Look for investment opportunities which will increase your net worth and provide long term financial benefits. This could include a Registered Retirement Savings Plan (RRSP) for retirement savings and which could create another tax rebate for the calendar year because RRSP contribution reduce taxable income. Contribute to a Registered Educational Savings Plan (RESP) to then receive the government grants and grow the monies tax free to assist your children in paying for their post-secondary education. Or add to a Tax Free Savings Account (TFSA) to save and grow your money tax-free for a number of goals.
Decisions about how to make the most of a tax refund are influenced by many factors including your personal circumstances, current financial situation and stage of life. Take some time to carefully think through how the refund can best benefit you in the long run. In the current economic environment with rising interest rates and inflation it is especially important to create a plan to help successfully achieve financial goals.
FirstOntario Credit Union in partnership with Aviso Wealth has an experienced team of advisors specializing in various areas of wealth management, including retirement planning, investment management, estate and succession planning, individual financial risk management and more. These professionals are here to help you plan for the future and reach your financial goals. Visit www.firstontario.com/Investments or call 1-800-616-8878 ext. 1700 to connect with a FirstOntario advisor and start growing your wealth today – your way.