Use Your Tax Refund to Bring Even More Money into Your Pocket
If you’re like most Canadians, you’ll be getting a refund when you file your taxes. That money usually takes about two weeks to arrive, and most people are tempted to spend it on something frivolous. There’s no denying that getting this “found” money is an amazing feeling, but in reality, the government is simply returning the cash that you lent them, interest free. What you do with your tax refund is totally up to you, but please consider closing out that Amazon shopping cart window and instead taking the following money-savvy approaches.
Pay Down Bad Debt
If you have any outstanding debt with an interest rate above 10% (most credit cards fall into this category), then you should immediately use your tax refund to pay that debt down. By doing this, you’re guaranteeing yourself a return equal to the interest rate of the debt itself.
For example, let’s say you get a tax refund of $1,000, and you make the wise move to pay down an equal amount of debt you’re carrying on a credit card with a 22.99% annual interest rate. You’d be saving yourself about $230 assuming you were going to carry that balance for a year. It’s highly unlikely you’d get a higher rate of return anywhere else.
If your tax refund doesn’t completely cover your credit card balance(s), you can still significantly reduce the card debt by pairing your refund with another tool: a balance transfer credit card. These types of credit cards allow you to transfer your outstanding debts to a card with a very low interest rate for a set period of time (usually 6-12 months). This gives you a chance to rapidly pay down your debt during the low-interest promotional period. The Canadian balance transfer card that we recommend for this purpose is the MBNA Platinum Plus Mastercard, which can provide an interest rate of 0% for the first 12 months of card membership.
Balance transfers on the Platinum Plus must be made within the first 90 days of an account being opened, and there is a 1% balance transfer fee (minimum of $7.50), but this fee isn’t comparable to the amount cardholders save with the low interest rate. As soon as the promotional period ends, the interest rate goes up to 21.99% for any unpaid transferred balances, so make sure you have a debt repayment plan in place.
If you don’t have major debt to pay down, the best thing you can do for yourself is invest. The nice thing about your tax refund is that if you reinvest it every year, that money can grow really quickly. Let’s say that every year you make $5,000 in Registered Retirement Savings Plan (RRSP) contributions and you’re in the 30% marginal tax rate. That would give you a refund of $1,500.
If you took that money and immediately reinvested it, you would now be making a contribution of $6,500 the following year which would give you a refund of $1,950. Thanks to the power of compound interest, after 10 years of reinvesting your tax refund with an an annual return of 5% on your investments, you would be up more than $23,000!
Save It for the Short Term
Whenever you have a short-term purchase in mind, it’s best to keep your money in cash as opposed to invested in the markets where that money could be at risk. A home down payment is a good example. You need to ensure your money is safe, so don’t take any chances by investing it. Alternatively, if you haven’t built an emergency fund, using your tax refund is a good way to get it kick started.
Regardless of what short-term goal you’re saving for, you can still make your money work for you by keeping it in a high interest savings account. These types of accounts are totally safe and your money will earn some interest while it’s parked. Look for an account type that gives the highest interest rate possible for the amount of money you can deposit into it.
Tangerine Savings Account
The Tangerine Savings Account has a daily interest rate of 1.10%, but quite often Tangerine runs promotions where new deposits earn 2.5% for six months. What makes Tangerine especially appealing is that you can withdraw money without fees from any Scotiabank automated banking machine.
Scotiabank Savings Accelerator Account
With the Scotiabank Savings Accelerator Account, you’ll earn 0.05% interest on amounts between $0 – $4,999. There are no fees for this account and it’s available in Tax Free Savings Accounts and other registered plans. Note that if you wish to make a debit transaction directly from this account, it’ll cost you $5 each time.
EQ Bank Savings Plus Account
With an everyday interest rate of 2.30%, the EQ Bank Savings Plus Account gives you the best bang for your buck when it comes to savings accounts. There are no monthly fees, no minimum balances, and unlimited transactions, which gives you quite a bit of flexibility. You also get five free Interac e-Transfers per month which helps offset the fact that you can’t withdraw cash directly from your account.
Pay Down Your Mortgage
Depending on the terms of your mortgage contract, you may be allowed to make an annual lump sum payment equal to 5% – 25% of the value of your mortgage. What makes this strategy so great is that any additional prepayments you make towards your mortgage go 100% against your principal. Not only will you end up saving a lot of money on interest over the long run, but you’ll also be mortgage-free sooner. You can’t complain about that right?
Build Your Credit Score
Did you know that you can use your tax refund to help build your credit score? Let me explain:
Let’s say your credit score is currently below 600, which is considered poor. If you get a secured credit card your credit score will slowly increase as you make your payments. This is possible because of the security deposit that’s required, which can be up to two times the credit limit on the card. Coming up with that deposit amount can be tricky for some, which is where a tax refund comes in handy.
By putting down a security deposit, you’re proving to lenders that you are creditworthy. It may take some time, but your credit score will slowly go up as you make simple purchases on the card and repay them in full at the end of each month.
Among secured credit cards in Canada we generally recommend the Home Trust Secured Visa card, in which the card’s credit limit is based on the security deposit. You can put down as little as $500 or as much as $10,000. If you decide to cancel your card, you get all of your money back once the card’s outstanding balances are paid off. People who have recently been discharged from bankruptcy or are in a consumer proposal can apply at any time. The card does come with a 19.99% interest rate—so it’s absolutely essential that you pay off your balance in full each month—but there is no annual fee.
Contribute to Your Child’s Registered Education Savings Plan
Setting aside enough money to pay for your child’s education can be tough. If you have children, consider using your tax refund to make a contribution to their Registered Education Savings Plan (RESP). As part of the Canada Education Savings Grant (CESG), the government will match any RESP contribution you make by 20% (up to $500 per year). That means you would need to make a yearly contribution of $2,500 to max out the CESG grant. There is a lifetime CESG of $7,200 per beneficiary, so make sure you start investing early.
Take a Vacation
What’s the point of working so hard if you can’t enjoy yourself a little right? I certainly understand that you would want to take your tax refund and put it towards your vacation plans, but instead of taking the full amount, how about setting a limit of spending just 25% of your refund? By doing this, you can spend that money guilt free since you’ll know that the majority of your tax refund is going toward one of the more practical routes listed above.
Setting aside ‘only’ 25% of your refund might still be enough for a great vacation, as long as you travel smart. Save money on your lodgings by charging them to a hotel rewards credit card, like the MBNA Best Western Mastercard. Making a single eligible purchase on the card grants you 20,000 Rewards points—enough for a free night’s stay. That’s a big benefit for a card that has no annual fee. Plus you’ll get travel protection, lost luggage assistance, and rental car coverage as added benefits.
You can also cut down on the cost of your airfare with a flight-oriented travel rewards card, like the American Express Gold Rewards card. It comes with a $150 annual fee, but this is more than balanced out with 25,000 Rewards Points (about a $250 value) when you charge $1500 to the card in your first 3 months of membership. Plus the card generates 2 points for every $1 spent on travel-related purchases, and 1 point per $1 everywhere else. Points can be redeemed on your flights *after* you purchase the tickets, making it one of the most flexible travel cards out there.