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Ways to Be Smart With Your Tax Refund

04/14/2015 05:25 EDT | Updated 06/14/2015 05:59 EDT
Diane Macdonald via Getty Images

You may consider your tax refund to be an unexpected windfall but it is your money. Make sure you have a plan to spend it wisely.

According to Canada Revenue Agency's tax processing statistics in early April, more than half of the Canadians who have filed their returns received a refund with an average amount of almost $1,700. It sounds great if you are a tax-filer until you remember that a tax refund is money you overpaid the government during the year.

When we asked Canadians in a recent Leger survey, more than half were expecting a refund. A third didn't expect a return, up from 26 per cent in 2014. Quebec residents and households with kids under 18 were more likely to expect money back than other Canadians, at 67 and 68 per cent respectively. And the younger the respondent was, the more likely it was they expected a refund.

Tax refunds happen when more tax has been withheld from your paycheque than needed. This can happen for a number of reasons. The payroll department withholds tax based on the forms you completed when you were hired. So if you had a child during the year or got married, your tax withholding may not reflect the credits you are now able to claim. Or you perhaps you moved and have a number of moving expenses to claim. No matter how you prepare your return, make sure you understand why you are getting a refund. The government does not give money back to you for no reason.

So what are Canadians planning to do with their windfalls?

Turns out, we're pretty responsible with our tax refunds according to the same Leger survey. For 42 per cent, that money is going to pay down debt. Twenty-two per cent said they'd split between spending and saving, and 16 per cent said they would bank their entire refund. Two per cent answered they planned to spoil someone else with their refunds; fingers crossed they're friends of mine.

The decision about what to do with your tax refund is particularly important to those young Canadians anticipating a refund. You want a vacation (10 per cent will spend their refund on that), and there's probably something you've wanted to buy and put off until you got your return (eight per cent will spend it that way). But consider this:

  • The sooner you start saving -- and making a habit of saving -- the better off you'll be in the long run. At the end of the day, who has more stashed away: the 25-year-old who puts away $100 a month for 10 years, or the 40-year-old who puts away $100 a month for 20 years? By age 60, the 40-year-old will have contributed $24,000 to an account. Assuming six per cent interest, compounded, he'll have earned $22,435 in interest, for a total of $46,435. The 25-year-old who contributed just $12,000 will have earned $61,537 in interest, for a total of $73,537. That is the power of compound interest.
  • If you've got debt, particularly consumer debt, the formula works in reverse -- the sooner you deal with it, the less you'll end up sacrificing in the long run. You will be paying a lot more in interest on your credit cards than you'll be earning in a savings account. So taking care of the balance owing sooner rather than later is a smart financial move.
  • Consider a deposit into a Registered Retirement Savings Plan (RRSP) or Tax Free Savings Account (TFSA) depending on your savings goal. Contributions to your RRSP will probably result in a tax refund next year but your money is tied up. TFSAs allow you to save tax-free and provide greater flexibility if you need to withdraw funds.

There are lots of tempting ways to spend that refund, but remember that it was your money in the first place. Doing the fiscally responsible thing is not always the most exciting but usually it pays off in the long run.

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