Getting the best bang for your buck with your tax refund
High interest rates make choosing between paying down the mortgage and investing a bit trickier
It's tempting to go out for a nice dinner or even plan a weekend getaway after receiving your tax refund, depending on how big it is.
Unfortunately, getting the best bang for your buck when it comes to allocating that lump sum of money is a little more, well…boring.
"Number one, pay off credit card debt. You will not get a better return for your money than paying down credit card debt," said Becky Western-Macfadyen, a financial coaching program manager at Credit Canada, who also has more than 20 years of experience as a credit counsellor.
"Understandably as human beings we need to incorporate a few treats now and then, but the main thing is to focus that money on debt before frivolous expenses."
Getting out of debt is the best way you want to enter retirementMarc McIver, Paladin Financial
Alim Dhanji, a Vancouver-based senior financial planner at Assante Financial Management, agrees that high-interest debt should be a primary target.
"As a rule of thumb, prioritize paying off debts with the highest interest rates, such as credit card debt. Very few investments can guarantee a return anywhere close to the interest rate on most credit cards, usually around 20%," he told Yahoo Finance Canada.
He also suggests Canadians use tax refunds to build or top up emergency savings to deal with unexpected events such as sudden serious illnesses or job loss. He says emergency funds are best kept in a highly-accessible, no-risk vehicle such as a high interest savings account.
Mortgage vs investments
For those who carry little debt and have extra cash already set aside, the question of where to allocate a tax refund can come down to paying down the mortgage or putting it towards investments.
The question was somewhat more straightforward when interest rates were at rock bottom because Canadians could reasonably expect to earn a higher return on investments compared to the interest rate they were paying on their mortgage, which might have been in the very-low single digits.
With interest rates relatively higher now, Marc McIver, a senior financial advisor at Calgary-based Paladin Financial Inc., says eight times out of 10, he would likely advise clients in good financial standing to put their refund towards the mortgage rather than investments.
"When your mortgage is six or seven (per cent), it's pretty hard to get an investment that's going to pay that without taking a whole bunch of risk," he said.
"Getting out of debt is the best way you want to enter retirement."
When it comes to investing, McIver says he favours Tax Free Savings Accounts (TFSAs) over Registered Retirement Savings Plans (RRSPs).
"Tax free beats tax deferred hands down every time," he said, while emphasizing the need to invest the money in these accounts rather than use them solely as a savings vehicle.
Western-Macfadyen takes the other side of the debate in that she prioritizes retirement savings over mortgage lump sum payments because the mortgage is already on a set payment schedule with an end date.
"The savings are going to be what carries you through the future. … You want to make sure the foundation is set first," she said.
"(The mortgage is) definitely on the list of what to do with the money. But you want to make sure your savings are taken care of first. If your RRSP is in good shape, then it goes on the mortgage."
A $19,000 refund
While filing income taxes can be daunting, Western-Macfadyen refers to one recent client's story to demonstrate how essential it is to file on time.
She says she learned a client had not filed his taxes for 12 years because it felt too overwhelming. After some encouragement, he worked through it and caught up on his taxes.
"At the end of filing, because it was 12 years, he got a refund of $19,000," she said.
It was "life-changing" for the client, she says, because he was able to pay off his debt and boost his savings.
"I use that story to reinforce how important it is to file your taxes. It's a must, it's not a should," Western-Macfadyen said.
Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.
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