Spend, Save, Pay off Debt or Invest? What You Should do With Your Tax Refund

Do you remember the good old days when spending our tax refund as soon as we received it wasn’t such a big deal?

The job market was stable, house values seemed to be on a never-ending climb and the stock market was booming.

We are now a lot more cautious about our spending habits and immediately booking a great vacation or buying a new flat screen TV may not be the best choice. When that money comes in, you still have to make a decision about what to do with your income tax refund.

Tips on What to Do With Your Income Tax Refund

Consider your overall financial situation before you make any decisions.

You can’t make any choices about what to do with your income tax refund unless you look at the big picture first:

Do you have an emergency fund? If so, how much do you have saved?

How secure do you feel in your job? What are your prospects for finding another one?

How much debt are you carrying?

Evaluate your existing emergency savings fund

You’ll want to have at least three to six months of living expenses set aside in case of a layoff or other financial crisis. If you haven’t been able to set aside much in the way of savings so far, use your income tax refund to start building up your reserve.

You may want to open up a low-rate line of credit to help make up for the shortfall in savings. It’s available to you when you need it, but you will need to be disciplined enough to use the line of credit ONLY to help pay bills or emergency expenses in the event of a job loss or other financial crisis.

If you have adequate savings in place, you should look at the next best use of your income tax refund.

Review your current debt load and make a plan for paying down debt

After you have reviewed your current debt load, either consolidate your loans into a one low-rate loan or start aggressively paying down any high rate loans. You would be quite surprised at how many people have no idea how much they owe and what it is actually costing them to borrow it. Most often this situation occurs because we have way too much debt and it’s all over the place. So we need to simplify our debt.

We can do this by taking all our loan statements to our banker and ask if they can consolidate them into one, low rate, manageable loan. If you have only one loan payment, it not only makes life much simpler but also makes getting out of debt much more ‘doable.’

Now if you have some high interest rate loans that you cannot negotiate into a lower rate loan then I would highly advise you to make it a priority to start aggressively paying them down. Use your tax refund here.

What if you have already paid off your debt and have a sizeable emergency fund-then what?

Take the income tax return and invest it

If you have a healthy savings account and are debt-free with the exception of your low-rate mortgage, consider investing your income tax refund. This strategy is especially sound if you happen to be in a higher tax bracket. Consider investing the funds into your RRSP to create an ever-growing nest egg. A $10,000 contribution would generate a $4,000 refund at the 40% marginal tax bracket, which you can re-invest into the RRSP again next year.

Summary

It’s important that you understand your unique financial circumstances before making any decisions.

Use the refund productively and resist the temptation to spend it on frivolous items. In the long run you will be better off having money in the bank, with little to no debt then a big-screen TV or just the memory of a two week vacation.