What to Do with Your Tax Refund

This article is part of our Finance Hub.

With any luck, filing your tax return will result in a tax refund. It’s always nice getting cash back, and now can feel like the time to splurge on something fun, like a shopping spree or a weekend away. However, if you really want to get the most out of your refund, you might want to hold off on booking those all-inclusive tickets.

There are plenty of great ways to take your tax refund and turn that money into smart financial moves. After all, your return isn’t coming out of thin air: it’s a percentage of your hard-earned income over the past year. Instead of falling into the lifestyle inflation trap like most, why not use this opportunity to make more money?

If you want to use this year’s tax refund wisely but don’t know where to start, here are our top tips to use that cash injection to get ahead:

1. Start an emergency fund

While you hopefully won’t need to use it, it is a good idea to have some money set aside in case of emergency. It can be used for urgent, unplanned expenses such as car repairs, emergency travel, burst pipes or even employment insecurity. The pandemic of 2020 is an example of why it is important to be prepared for the unexpected.

While there is no set rule on how much to set aside, three months of expenses is generally a good place to start. While this number may be higher than you expect or currently have saved, your tax refund could be a great starting point to save. After this initial amount, you could start a regular deposit into your emergency fund, even if it’s only a small amount each month. Your future self will thank you for the financial safety net.

Deposit it directly into savings

The great thing about getting your tax refund is that you can set up a direct deposit, which usually means that you get much quicker access to the money. It also means that it will be a lot easier to save that money by not even letting it even touch your checking account. Instead of sending it to your primary checking, why not set up your direct deposit so that your refund goes into your savings?

Cut yourself out as the middle man entirely, and you’ll never have to worry about the temptation of a splurge purpose. Bonus points if you can keep it in your savings account for a few years and start earning some interest! Saving money and building on it is also a great way to avoid taking a costly loan out in the future.

Pay off your debts

Credit cards can be an effective tool for managing cash flow or building a credit score, but there is the potential to amass more credit card debt than you had planned. Outstanding balances on a credit card will keep charging you interest, so it’s a good idea to pay them off ASAP and minimise your overall repayments. Similar to the concept of energy efficiency. The idea is to minimize and optimize.

If you decide to use your tax refund on a credit card debt, aim to pay the largest debt off first (often this will be the one on the card with the highest limit). This will improve your credit score, and may even inspire you to make staying debt-free a financial goal this year.

Put it towards a big purchase

Maybe you’re thinking about trading in your old car for something a little newer, thinking about buying your first house, or planning to go on a vacation. Setting aside a larger down payment can make a big purchase like a new car or a home much more affordable over the long run. Not only will you lower the total amount that you will pay over time, but you also might be able to get long-term advantages, such as a lower interest rate.

And in the case of buying a home, where your initial costs are naturally going to be much higher, you might not even be able to start the home buying process without a large sum of money set aside for the down payment, closing, and any additional expenses like inspections, renovations, appliances, or moving supplies.

Think of your retirement

Saving for retirement can be a heavy lift—after all, you could easily be preparing to live without a steady paycheque for anywhere between ten to twenty years or more. Every bit helps when it comes to contributing toward your retirement savings, and putting your tax refund towards those golden years can make a huge difference. In fact, starting a retirement plan is one of the most popular money saving tips given by most dads.

If you’ve already started the process of saving for retirement, you might have a Registered Retirement Savings Plan (RRSP) or a Registered Retirement Income Fund (RIF). Or, you could have a Tax-Free Savings Account (TFSA). Whatever account you choose, take whatever funds you get from your tax return and send it straight to your retirement.

The added benefit is that by making a larger retirement contribution today, you are making your 2020 tax burden much lighter. It’s a tax-free contribution, so good news: you can deduct any money you set aside from your income and decrease the likelihood that you’ll end up with a big tax bill next year.

Consider investing in the stock market

If you have been considering finally investing, a good place to start is online. It may be time to dip your toe into the stock market, and the good news is that it’s easier than ever these days. You could get a financial planner, but another option is a robot-advisor.

Robo-advisors provide sophisticated algorithms, comprehensive dashboards, and interactive reporting that allows you to take a set-it-and-forget it approach and still see long-term benefits (after all, we don’t all have the time to become investment professionals overnight).

Take a look at robo-advisors in Canada to see your options. It’s a good place for beginners to start investing—and compared to traditional investing, robo-advisors tend to offer benefits like lower management fees, quick access to funds, and 24/7 reporting.

Make a commitment to always invest your tax refund, and you could see your investment account grow by thousands over time. It’s not a bad way to create a safety net—and if you get lucky, maybe even some wealth.

Invest in yourself

Throughout the year there have probably been things that you have been eyeing up, but have just cost that little bit too much. It may be paying for a that certification or class, a stand-up desk to upgrade your home office, or a professional conference that will help you network with your dream clients. Use your refund to take that next step and do something for yourself.

By growing your knowledge, experience, and expertise, you are making an investment in your future. And who knows, that investment may lead to getting a promotion or a raise somewhere down the line, growing your financial health over time.

No matter how you choose to spend your tax refund, take some time to think about your options and choose what feels right for your personal situation and your financial needs.

It should be a plan that sets your finances on a path to success—not only today, but five, ten, or twenty years down the line. And while using your tax refund for the greater financial good might not be as exciting as blowing it all on an epic shopping spree, the payoff will be much, much greater.

Some tax tips are good forever. Check out our tax guides from 2016 and 2020!