How to get the most out of your tax refund Add to.
Okay, I'll be the first to suggest that a large tax refund is actually a bad thing.
That's right. If you're expecting a refund some time soon, it means that you have effectively leant money to the Canada Revenue Agency (CRA) - without interest. That was generous of you.
Fact is, many of you are expecting a refund. My friend Paul and his wife Carol Ann are no exceptions. Paul's expecting $2,347.32 back from the taxman some time in the next couple of weeks. "Tim, I just want to make a smart decision about how to invest that money," he asked recently. "What do you suggest?"
"Paul," I answered, "I was talking to Carol Ann and she mentioned that she's been wanting to refinish the hardwood floors in your living room. She said that was going to cost about $2,200. That leaves $147.32 for you to invest. I think you should invest it in a day at the ballpark. You can take me to a Jays game."
For those of you, however, who are going to have a few more dollars to work with, what should you do with your tax refund? Let me share some ideas.
Contribute to an RESP
I've done the math. If you start saving for a child's education in his or her first year, setting aside $2,000 annually will provide pretty close to what that child will need for a postsecondary education. Now consider this: If you had made a deductible $5,000 RRSP contribution for 2008, you can expect about $2,300 in tax savings if you're in the highest tax bracket (likely coming back as a refund), and $2,000 of that could be contributed to a registered education savings plan for your child. An eligible child will receive $400 in grants from the government on a $2,000 contribution (the maximum grants would be $500 on a $2,500 contribution each year). What a great way to use tax savings to generate even more money back from the government.
Service an investment loan
Here's an idea that can really boost the value of your retirement savings. When you're a good candidate to borrow to invest, consider using your tax refund to cover the interest costs on an interest-only investment loan. For
example, a $3,500 tax refund would be sufficient to cover the after-tax interest costs on a $134,000 interest-only loan at 4 per cent ($134,000 times 4 per cent equals $5,360 in deductible interest, which equals approximately $3,500 in interest costs after taxes if you're in the middle tax bracket and have a 35-per-cent marginal tax rate). Now, there are several factors to keep in mind when borrowing to invest - a topic for another day - but the most important point to note is that this is a long-term strategy. Plan to leave your borrowed money invested for 10 years or more. This strategy is not for everyone, but it can effectively put your tax refund on steroids by getting more money working for you.
Get rid of bad debt
Now, there's good debt and bad debt. Bad debt has a very high rate of interest and is generally used for personal consumption or to buy assets that are depreciating in value, and the interest costs are not deductible for tax purposes. Typically, credit card debt is bad debt. One big benefit to paying down debt is that it provides a decent guaranteed after-tax return on the investment of that tax refund. For example, if you have a $4,000 refund to utilize, and you pay down bad debt that is accruing interest at, say, 8 per cent, that equates to a guaranteed 8-per-cent after-tax rate of return on that $4,000. Not too shabby.
Donate to charity
Why not donate all or part of your tax refund to charity? Consider this: If every Canadian who made an RRSP contribution in 2006 had donated his or her tax savings from that RRSP deduction to charity, it would have provided the charitable sector with an additional $3.3-billion or so, representing an additional 40 per cent in donations from Canadians. And don't forget, the taxman will provide even more tax savings when you make a donation, amounting on average to about 40 cents for each dollar donated, so your out-of-pocket cost will be even less than you think.
Stimulate the economy
Then there's always the opportunity to stimulate the economy by buying that new big-screen television or whatever catches your fancy. My friend Paul liked the sound of that.Source: www.theglobeandmail.com