With interest rates remaining high, advisors recommend using tax refunds this year to pay down debt.
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As Canadians receive their annual tax refunds, advisers recommend they focus on paying down debt and building up their savings.
As of June 3, the Canada Revenue Agency (CRA) had put more than $38-million back in Canadians’ pockets through refunds this tax season, with an average amount of $2,184 per taxpayer. Here’s what advisers are recommending clients do with their refunds.
Boost the emergency fund
Gesi Commisso, partner, certified financial planner and insurance representative with Vancea Financial Group at Investia Financial Services Inc. in Woodstock, Ont., recommends putting tax refunds toward an emergency fund.
“Especially this year, with everyone feeling the pinch of inflation and things costing so much, people have less wiggle room in their paycheques,” he says.
The Bank of Canada lowered its key interest rate on June 5 by a quarter of a percentage point to 4.75 per cent, a welcome change for many Canadians since the policy rate swelled to its two-decade high last summer. Still, Mr. Commisso says current rates make debt an expensive financial burden.
A tax-free savings account (TFSA) can be a great place for an emergency fund, he says, with high-interest savings account (HISA) funds offering a risk-free place to hold cash.
Mr. Commisso says that HISA funds have been a great beneficiary of high interest rates, paying out between 4 and 5 per cent over the past two years.
“Those interest rates are great for money sitting in cash, available to take out at any time,” he says.
Emergency funds can save clients from racking up more debt in “worst-case scenarios, such as when your washing machine breaks down,” Mr. Commisso says. “Those are situations in which people might use their credit card or line of credit, which adds to their debt.”
Pay down debt
While Mr. Commisso offers advice on a case-by-case basis, “generally, if a client is carrying debt, the best thing to do with their tax return is use it to pay that off.”
A report from TransUnion released in December found that the average credit card balance for Canadians was $4,265.
“The average interest rate on a credit card can be anywhere from 20 per cent to more than 25 per cent, so when you have $4,000 of debt, and take three months to a year to pay it off, that interest is compounding,” Mr. Commisso says.
Natasha Knox, an advice-only financial planner with Alaphia Financial Wellness in Victoria, says she encourages clients to use their tax returns to pay off larger debts such as mortgages.
“Think of the interest rate you save by paying down your mortgage as being the same as getting a guaranteed rate of return inside your TFSA,” Ms. Knox says.
For clients with a mortgage rate of 4 per cent who think they can generate a better return in a TFSA, “then rolling the dice on your TFSA would make sense,” she says. But the higher the mortgage rate, the more attractive it becomes to pay it down.
Make use of the new FHSA
For clients who are considering entering the housing market, the new tax-free first home savings account (FHSA) could be an attractive place to park a tax return.
FHSAs, which became available on April 1, 2023, allow Canadians who don’t yet own a home to contribute up to $8,000 a year to a lifetime maximum of $40,000. According to government figures released in December, more than 300,000 Canadians had opened the accounts.
“If your goal is home ownership, the FHSA is pretty much a no-brainer,” says John Iaconetti, financial adviser with The McClelland Financial Group at Assante Capital Management Ltd. in Thornhill, Ont., as contributions are tax-deductible and there are no taxes on withdrawals made to purchase a home.
“That yearly $8,000 contribution limit can help you get a bigger return,” he says.
For clients looking to keep money in their FHSA for less than two years, Mr. Iaconetti typically recommends using a HISA in FHSAs so their funds remain liquid.
Even for clients who don’t plan to buy a home in the near future, he says the FHSA is still valuable because the account can grow tax-free until they’re ready to make a purchase. FHSAs can remain open for 15 years, after which the amount can be rolled into a registered retirement savings plan (RRSP) if the client doesn’t end up purchasing a home.
Top up your RRSP
Contributing to an RRSP also provides a tax deduction, making it a good place to park money from a tax return.
Mr. Iaconetti recommends diversified mutual funds or exchange-traded funds.
“As long as the fund is diversified and you plan to keep the money in there long term, you should have no issues,” he says.
That includes all-equity portfolios, which can offer higher annual returns. However, he recommends funds with a low management fee.
“Oftentimes, people make an incorrect decision by buying an investment with high management fees, which eat into their returns,” he says.
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