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• Apr. 18, 2024

Getting an income tax refund may feel like a windfall of found money.

But that's not really the case. A tax refund isn’t exactly found money. If you receive a tax refund from the Canada Revenue Agency (CRA), it means you overpaid your income taxes throughout the year.

If you are expecting a refund, you might already be thinking about how to spend it before it even hits your bank account.

Maybe you're thinking about a vacation, a night out, or some big purchase for your home – or whether you should save it, invest it, or use it to pay down debt.

Depending on how much you get back from the CRA, you might be able to allocate portions of your refund towards your personal financial goals. Once that money is back in your hands again, it could be used to pay down debt, start an emergency fund, or contribute to other financial goals.

Here are five ideas for what you could do with your tax refund:

Pay down high-interest debt

If you're carrying a balance on your credit card or line of credit, or if you've got student loans or car loans, using your tax refund to pay down the balance could help you pay off these debts faster.

To get started, the Financial Consumer Agency of Canada (FCAC) recommends prioritizing your debts so you can develop a strategy towards paying them off.

One strategy is the "debt avalanche" method, which targets paying off high-interest rate debt first, such as credit cards or payday loans. That doesn't mean you ignore any additional debts on your plate – you should still make at least the minimum monthly payments for all of your other debts, while funneling any extra money (such as your tax refund) toward paying off the debt with the highest interest rate.

Even if your tax refund isn't enough to clear your entire debt load, you can still shrink the amount you owe which can help reduce the overall amount of interest paid over the life of the debt in question.

Make a lump-sum mortgage payment

If your mortgage contract allows it, using your tax refund to make an extra mortgage payment can help accelerate your journey to being mortgage-free. Making prepayments can help cut down your amortization period and result in paying less interest over the course of your mortgage term.

First, it's important to find out whether you have an open or closed to prepayment mortgage. For example, open to prepayment mortgages allow homeowners to prepay any amount of their outstanding balance at any time without prepayment charges (some administration fees may apply).

On the other hand, closed to prepayment mortgages could still give you the option to make a maximum lump-sum payment each year. At TD, that number can be up to 15% of the original principal amount each calendar year. If you want to prepay more than 15%, a prepayment charge may apply. You can use the TD Mortgage Prepayment Calculator to help you estimate your prepayment charge so you can understand the costs of making a prepayment.

Build your savings

Whether your tax refund is $100 or $1,000, using the money to start a savings account or to bolster existing savings can help give you a head start towards your savings goals. It doesn't matter what those goals are – a tax refund can be used to save for long-term goals such as retirement or a down payment on a home, or shorter-term goals such as a wedding, new car, travel or home renovations.

If you don't have an emergency savings fund, creating one with your tax refund is an idea worth considering. Having an emergency savings fund that you can turn to in case unexpected expenses arise can be very helpful. You can start with as little as $25.00 each month. You may be surprised how quickly this regular amount can add up over time and how having an emergency savings fund can help ease the burden of unexpected expenses.

Invest for the future

If you've already set up an emergency savings fund and are well on your way to paying down any existing debt, it could be time to consider contributing to a Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP). All interest and earnings in a TFSA account grow tax-free, and you aren't charged tax when you make withdrawals. Contributing to an RRSP helps you to save for your retirement while also reducing your taxable income, and all interest and earnings grow tax-free in the account. With an RRSP there are additional rules as to when withdrawals must be made, which you can read more about here on the TD website.

Both TFSAs and RRSPs can hold a variety of investment options such as cash, GICs, and mutual funds. Generally, you don't need a lot of money to open a TFSA or RRSP and you may be able to make regular, small contributions to start. But it’s important to note that both TFSAs and RRSPs have contribution limits.

Spend it and invest in yourself

If your finances are in good shape, there's nothing wrong with spending your tax return on something for you. You could enroll in training, certification or a professional development course to help boost your career, or you might consider using your tax refund to pay for a gym membership to improve your overall fitness, or purchase a wellness tracker to set and achieve personal fitness goals. You might even consider a weekend getaway, a day trip or even a special night out for dinner.

Whatever you decide, make sure treating yourself fits in with your overall budget and how much you want to allocate to your financial goals.

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