What should you do with your tax refund?
What do most people do with their tax refunds? They spend it of course! It’s bonus money, fun money,
But in tighter economic times when all you hear is about high debt levels, low savings rates, a growing retirement gap, and fear of inflation, could this be the year to do something fiscally responsible with your tax refund?
If you are prepared to be fiscally responsible, here are two strategies to determine the best course of action
Principles of cashflow
The principles of cashflow deal with the mathematical effectiveness of cashflow. If you have an extra dollar, what is the best use of that dollar? It does not matter if you have $10, $100,000 or more, the principles of cashflow simply suggest what gives you the best bang for your buck. It’s important to keep in mind that everyone has unique circumstances and you should consult a financial advisor for a detailed review of your personal situation but here are some generalized rules of thumb:
- Pay off high-interest credit card debt first. The credit card math will work against you every time especially if you are paying 18% or more in interest. Paying down this debt is always a great place to start if you have extra money. It’s also important that you have the discipline to NOT accumulate the debt again once you pay it down.
- Look at the RRSPs first to see if they make sense. One of the benefits of making an RRSP contribution is that you get a tax deduction. The best way to see if the tax deduction benefits you is to follow my ONE FORMULA approach to RRSPs – If your marginal tax rate (MTR) at the time of contribution is greater than your marginal tax rate at the time of withdrawal, then the RRSP will always give you a benefit.
- Paying off non-deductible can be a great investment. Just check out the math in this article – paying down debts. Basically paying down a 6% debt can be the equivalent of earning 8.8% on a GIC. Paying down non-deductible debt can be a great investment. The higher the cost of interest, the better the investment.
- Buy TFSAs. One of the problems with TFSAs is the title has misled a lot of people into putting their money into low earning savings accounts when there are lots of ways to invest TFSAs. TFSAs have a lot of universal appeals so they could easily move up the list depending on your personal circumstances.
The balanced approach
The theme is about finding balance and when it comes to extra money, the balanced approach refers to dividing up the money and doing many things with it including having some fun. Some personal finance pundits have called this the conscious spending plan. It’s in fact, what I am teaching my kids about money.
When it comes to money I am teaching my kids that when you have money, there are 4 things you can do with it. You can spend it, share it, saving it or invest it.
A conscious spending plan says you will consciously allocate your money according to the plan whether it’s your money paycheques, a one time tax refund or a large inheritance. You can set different spending plans for cashflow versus lump-sum amounts.
Here’s an example I did with my kids. I gave them $100 and asked them to allocate this money into 4 pots: Spend, Save, Share and Invest. They all did different things with the money but I then said this would be their spending plan where anytime they came into money, whether it was $20 from grandma and grandpa, or $5 from their allowance money from their summer lemonade stand, they would allocate the money, in the same way, every time.
Although they are pretty young kids, I wonder why adults who are theoretically capable of making better, smarter and more prudent decisions don’t do the same thing. Maybe this is the perfect balanced approach to dealing with a tax refund: Spend some of it, save some of it, share some of it and invest some of it.
What do you do with your tax refund? Any other great ideas to share with others?