What to do with your tax refund

Tax season is here, and many Canadians have already filed their taxes and are awaiting a potential tax return. As of the latest update on April 22, the average tax refund in Canada works out to quite a sizeable chunk of change: $2,126. So if you’re getting a tax refund, what should you do with it?

While many people view a tax refund as a windfall of free cash, in reality, it’s your own money that you didn’t collect on your paycheques during the year. Think of it like an interest-free loan you made to the government, and now you’re finally getting your money back.

A recent poll by CIBC’s Investors Edge shows that fewer Canadians are investing their tax refund than in previous years. Only 12% of Canadians are investing their tax refund this year. Many more Canadians (39%) are planning to hold their refund as cash, while nearly a quarter (24%) are paying down debt and nearly a third (29%) will be using their refund to spend on essentials. Luka Marjanovic, managing director and head of Investors Edge, points out that high inflation quickly reduces the value of cash, so rather than just holding your tax refund as cash you could spend it on investments that will help you grow that money for your future.

Although it may be tempting to use your tax refund for an online shopping spree, there are ways you can put your money to work to benefit your future self and help you reach financial goals like retirement or a downpayment on a home. Here are seven ways you can use your tax refund more wisely.

1. Pay off credit card debt

If you don’t pay off your balance in full every month, you’re carrying debt on your credit card. If that’s the case, using your tax refund to pay back some or all of your card’s balance is virtually a no brainer.

It all comes down to the hard numbers.

With most credit cards charging exorbitantly high interest rates of 19.99% annually, paying down your debt is almost like getting an instant and guaranteed 19.99% return on your money. 

According to the latest numbers from TransUnion, the average credit card balance in Canada is $4,430 (up 8.69% compared to the same period in 2022). If you were to receive the average tax refund of $2,126, you could pay off almost half (48%) of your balance and decrease interest payments significantly. 

Aside from saving money on interest, using your tax refund to pay off your credit card debt has other benefits too.

It’ll lower your overall debt load relative to your card’s credit limit (aka your credit utilization ratio), which can help to give your three-digit credit score a boost. With a lump-sum payment, you can also get out of debt faster since you’re aggressively paying down a bulk of your credit card debt at once as opposed to gradually over time while interest continues to accrue.

2. Pay off other debts

If you owe money on other debts aside from credit cards, deciding where to put most of your tax refund will depend on a few factors.

First, you’ll want to identify your high interest debts (there isn’t a strict definition here but this generally encompasses loans with rates of at least 8% to 10%). Next, organize your debts in order of interest rate from lowest to highest, and focus your efforts on tackling the latter. For instance, if you have both a car loan with a 10% interest rate and credit card debt at 19.99%, you would want to put your tax refund towards the card’s balance as a lump sum payment.

What if you owe lower interest debts? Like, say, a line of credit with a 4% APR? Well, that generally depends on your financial goals and personality. Some argue you could invest your money instead of prioritizing paying off low-interest loans and come out ahead. Others believe in the merits of living a debt-free lifestyle – no matter the interest rate.

3. Start or increase your emergency fund

Whether or not you owe debt, you might be thinking about investing your tax refund. But before you do that, ask yourself: do you have any cash set aside for emergencies?

Without an emergency fund, you could be forced to go into debt or suddenly sell your investments if your car needs to be repaired, you forgot about a property tax bill that needs to be paid, or you lose your job. Many financial experts recommend you should have at least three months’ worth of living expenses saved, and if you don’t already have that set aside in a high interest savings account, a tax refund can help get you closer.