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Not sure how to make the most of your income tax refund? Our guide will show you which options are the most lucrative, so you can determine how to use your tax refund wisely.

Nearly 18.7 million Canadians got a refund during last year’s tax filing season (Feb. 2019 to Jan. 2020), with an average refund totalling $1,740. That’s a substantial chunk of change that can go a long way if you know how to use your tax refund wisely.

To help you get the most bang for your buck, we crunched the numbers to find out how much you could expect to save or earn over 10 years by putting an average $1,740 tax refund to various uses.

Here are the top six ways to use your tax refund, along with an accounting of estimated 10-year returns in real-dollar terms.

1. Invest in an RRSP

Using your tax refund to contribute to a Registered Retirement Savings Plan (RRSP) is one of the smartest things you can do because it helps you in two ways.

First, eligible RRSP contributions are tax-deductible, so you’ll get a break on next year’s income taxes. Depending on your tax bracket and province/territory of residence, a $1,740 RRSP contribution will save you between $479 and $869 in income taxes the following year.

Second, funds inside an RRSP are sheltered from tax, which means that any income you earn on those savings will compound over time tax-free. If you invest a $1,740 tax refund in a low-fee diversified portfolio that provides even modest average annual returns of 5% to 7%, in 10 years that amount will have grown to $2,835 to a $3,420 — or $1,095 to $1,680 in investment earnings.

Estimated returns: $1,575 to $2,550

Not sure how to set up a low-fee investment portfolio that works for you? Check out one of Canada’s robo advisors or discount brokerages, such as Wealthsimple or Questrade, which create customized low-fee portfolios for first-time investors, and also offer a full-slate of investment assets for those who like to go DIY.

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2. Save or Invest in a TFSA

A Tax-Free Savings Account is another good destination for your annual windfall since it too allows your interest and investment income to compound tax-free. In 2020, the TFSA contribution limit is $6,000, so even if you’ve used up all your previous contribution room (a cumulative total of $69,500 since 2009), you may now have new room to accommodate your tax refund.

Unlike RRSP contributions, you won’t get a tax deduction when you contribute to a TFSA. However, you also won’t pay any tax when you take out the money, which is a big benefit over RRSP withdrawals that are taxed at your marginal income tax rate.

How much you earn on a TFSA contribution of $1,740 will depend on whether you save it or invest it. If you plan to use the money in the next year or two, a high-interest savings account or GIC might be the best option. That way, you can access your money when you need it but still earn some interest. For example, EQ Bank offers competitive interest rates on both TFSA bank accounts and GICs. (For more information, see Young and Thrifty’s Best TFSA Saving Account Rates.)

If, on the other hand, you do not plan to use the money for several years, investing in a low-fee diversified portfolio will provide higher average annual returns over the long term. Assuming those returns are around 5% to 7%, in 10 years a $1,740 TFSA contribution will have earned $1,095 to $1,680 in investment income. Using a robo advisor (like Wealthsimple) is a great option for your TFSA because you’ll save money on management fees while growing your investments. For a limited time, Young & Thrifty readers get an exclusive $100 cash bonus deposited into their account when they open and fund a Wealthsimple Invest account (min. $1000 initial deposit).

Estimated returns: $220 to $1,680

*Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.

3. Pay Off High-Interest Debt

Carrying high-interest debt — including credit card debt — is one of the worst things you can do to your finances because you may end up paying oodles of interest above and beyond the amount you originally borrowed. Conversely, paying off such debt is like getting a guaranteed high-interest return on investment.

For example, if you paid down $1,740 of an outstanding credit card balance (with a 19% APR, the average credit card interest rate in Canada) instead of making the minimum payment (3%) each month, in 10 years you will have saved a whopping $1,596.38 in interest charges.

Obviously, the higher the rate of interest you are paying on the debt, the more money you can save by using your tax refund to pay off that debt. One way to bring down the interest is to get a low-interest credit card or to move your outstanding debt onto a credit card offering o% interest rate on balance transfers. This smooth move could save you big bucks in interest charges.

Estimated returns: $1,595

4. Invest in an RESP

If you have children, investing in a Registered Education Savings Plan is another highly effective use of your tax refund dollars. That’s because the government kicks in a grant of 20% on annual RESP contributions of $2,500 or less — which is up to $500 a year in free money (with a lifetime limit of $7,200).

A $1,740 RESP contribution would give you a Canada Education Savings Grant of $348, which would bring the total amount invested to $2,088. After 10 years in the tax-sheltered portfolio, assuming 5% to 7% average annual returns, that amount will have grown to about $3,400 to $4,105 — a gain of $1,660 to $2,365 from your initial $1,740 RESP contribution.

You can open an RESP with most of Canada’s best robo advisors, but our top choice is Justwealth because it offers target-date portfolios – an investment portfolio that shifts its asset mix automatically over time, eventually “maturing” in the year your child needs the money for post-secondary education. The cash bonus of up to $500 when you open a new Justwealth account is also enticing.

Estimated returns: $1,660 to $2,365

5. Pay Down Your Mortgage

Another popular use for a tax refund is to lower your mortgage debt, which saves you money on interest charges over the life of your mortgage. Of course, how much you can save depends on the size of your mortgage and your interest rate. If you’re looking to pay down your mortgage faster, you may want to consider refinancing your existing mortgage. A mortgage broker like Breezeful can help you get the most competitive interest rate possible, which could shave off years from your mortgage amortization and save you thousands of dollars.

If you have $300,000 remaining on your mortgage, and you pay annual interest of 4% via monthly payments, a one-time prepayment of $1,740 will save you $817.04 in interest charges over a 10-year period.

Debating whether to pay down your mortgage or invest the extra money? It’s a good question — one that we tackle in Should You Pay Off Your Mortgage Early or Invest The Extra Cash?

Estimated returns: $817

6. Boost Your Home’s Energy Efficiency

There are many things you can do to improve your home’s energy efficiency, which can save you money on your electricity, gas or oil bill. For example, you can insulate your walls, basement or attic, buy a more efficient furnace, hot water heater or air conditioner, or replace windows and doors to prevent air leakage.

It’s hard to say exactly how much you can save by improving your home’s energy efficiency since the calculation depends on several factors including:

  • The type of renovation/improvement
  • Your current energy consumption
  • Your local energy costs

As an example, however, if you were to spend $1,740 on insulating your home — which might reduce your heating/cooling expenses by 10% — and you currently pay $2,500 a year to control the temperature in your home, that would save you $250 per year, or $2,500 over a 10-year period. Once you subtract the initial cost of the insulation, your total savings would be $760. (Note that some provinces also offer rebate programs or  other incentives for energy-efficient home improvements, which would boost your savings even further.)

Estimated returns: Varies

Comparing Ways of Using a $1,740 Tax Refund

MethodSavings/Earnings after 10 years

Invest in an RRSP$1,573.27 to $2,551.84 in tax savings and investment income

(includes $479 to $869 in tax savings on next year’s return, depending on tax bracket and province of residence; and $1,094.27 to $1,682.84 in investment income, based on average annual investment returns of 5% to 7%)

Invest in an RESP$1,661.13 to $2,367.41 in investment income

(includes $348 CESG payment invested, and average annual returns of 5% to 7%)

Pay off credit card debt (19% APR)$1,596.38 in interest savings

(as compared to making the minimum payments on $1,740 of outstanding debt for the 10-year period)

Save or invest in a TFSA$220 to $1,682.84 in interest or investment income

(based on GIC or savings account interest of 2.4%/year; and average annual investment returns of up to 7%)

Pay down your mortgage$837.04 in interest savings

(based on a $300,000 mortgage, 4% interest rate and 25-year amortization)

Boost your home’s energy efficiency Savings vary based on type of home improvement and local energy costs.

(e.g., if you spend $1,740 on insulation that saves you 10% off annual heating/cooling costs of $2,500, you’ll save $2,500 over 10 years (or $760 in total, after subtracting the cost of the insulation)


Final Word

There are lots of ways to increase the value of your tax refund, from investing in registered accounts like RRSPs, RESPs and TFSAs, to paying down credit card or mortgage debt, to improving your home’s energy efficiency. Obviously, any of these options will put you farther ahead than blowing your tax refund on a shopping spree, so consider each choice carefully and pick the one that works best for you.

Get $100 when you open your first Wealthsimple Invest account!

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