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The best ways to spend your tax refund

Believe it or not, more than half of the 24 million-plus tax filers in Canada are entitled to a refund if past experience is any indication. In 2002 and 2003, about 14.7 million of the 24 million tax filers received a refund, according to the Canada Revenue Agency. The average refund was just shy of $1,200.

Rather than blow the expected windfall on a trip or an iPod, financial advisors say there are ways to spend your refund that will improve your financial picture.

Chris Gordon, an investment adviser at Edward Jones, in Mississauga, Ontario, says "having extra cash is a good trigger to think about strategies for putting money to work for things that are important to you."

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Clear the debts
One way to get ahead is using that money to tackle outstanding loans. Gordon says if you have an RRSP loan, "it's important that you pay that loan off as soon as possible to minimize interest costs."

Adrian Mastracci, a fee-only investment counsellor at KCM Wealth Management, in Vancouver, says the "biggest bang for your buck is to pay off credit card debt."

If you're in a 40-percent tax bracket and have an outstanding balance on a card that charges 10 percent interest, you have to earn about $16.60 just to pay every $10 of interest debt. If the card charges 20 percent, you'd have to earn $33 to pay $20 of interest debt.

If your credit card is clean, Mastracci says look at your lines of credit, car loans or mortgage. "Anything that's not tax-deductible would certainly be a good place to put some money into."

Gordon says "paying down a mortgage is one option, even if the mortgage interest rate is low." That's because the interest charges over the long-term add up.

For example, the Bankrate.ca mortgage calculator, shows that if you have a $150,000 mortgage balance today at 5 percent over 25 years, your monthly payment will be $872.41. The amount of interest paid during that time is $111,722.24, about $372.41 a month.

If you applied a $1,200 tax refund to your mortgage in May of every year, you would pay off your mortgage almost five years ahead of schedule, saving $23,811.26 in interest and free up your cash flow.

Even a one-time $1,200 payment shaves almost four months off your mortgage. "It becomes a good investment in the long term," says Gordon.

Invest for the future
If you don't have a high debt load, think about ways to invest your refund, suggests Laurie Stephenson, a certified financial planner at Freedom 55 Financial in Halifax.

Consider contributing the money to your Registered Retirement Savings Plan now instead of waiting 'til next March. "Lots of people leave it 'til the last minute. It's an opportunity for the money to be working for you all year," says Stephenson.

The $1,200 could also go into a spousal RRSP plan, she notes, which can help split income in retirement. "You need to sit down with somebody and have a look at planning in the year ahead."

Gordon adds that the tax refund could also be used to pay off unused RRSP contribution room. Canadians have billions of dollars in RRSP contribution room building up.

Stephenson says parents might want to consider putting their tax refund into a Registered Education Savings Plan for their kids. "If you drop it into an RESP, you will immediately get a 20-percent grant from the government."

Known as the Canada Education Savings Grant, it provides up to $400 a year for those who make the maximum $2,000 annual contribution. A $1,200 contribution will generate $240, a 20 percent return, which is stellar in today's markets.

An alternative would be to use the tax refund to start an unregistered investment account. By investing outside of your RRSP, you can take advantage of the low capital gains tax. Investors who have a capital gain outside of their RRSP will only pay tax on 50 percent of that gain. "If you haven't got any RRSP room, it's nice to have some non-registered investments," says Stephenson.

Plan for a rainy day
Mastracci says another option for a tax refund is to put something away for a rainy day. "People don't really have much in their emergency funds." However, he says, make sure the emergency fund is held at a different institution from the one holding your loans in case you need to access it quickly. You don't want the bank laying claim to it to cover your debts if something bad happens.

He adds that you can also make a charitable donation and get a tax receipt that can be used to generate a refund next year.

If you are getting a tax refund, Gordon says you might want to reconsider the way you manage your tax payments. A refund means you have overpaid your taxes and that's essentially an interest-free loan to the government.

He says you can fill out a Canada Revenue Agency T1213 form, asking the government to allow your employer to reduce the amount of taxes taken off your pay. That way, you will have the money in your hands sooner.

While it's important to be disciplined in your finances, Mastracci says you also need to have some fun in life. "Put some of that refund into improving yourself." Take a cooking class or buy yourself something special. "Expand the horizon a little more for yourself. I think there's some value to saying, 'Maybe I'll do something for me.'"

Jim Middlemiss is a freelance writer and lawyer based in Toronto. He's a frequent contributor to the National Post, Investment Executive and Wall Street & Technology.

 
-- Posted: April 18, 2005
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