Almost 80 per cent of Canadians are expecting to receive a tax refund this year and about half are planning to save the money, up from 29 per cent last year, according to a recent survey.Olena Miroshnichenko/iStockPhoto / Getty Images
Receiving a tax refund can feel like a windfall, even though it’s only the government returning the extra money paid in taxes last year.
But Canadians should approach refunds with a waterfall in mind, says Anna Premyslova, senior wealth advisor and portfolio manager with National Bank Financial Wealth Management in Calgary.
Specifically, she thinks of tax refunds as a “cascading waterfall” that represents a hierarchy of financial needs.
“I always suggest making a mental or physical list of how I can allocate these dollars to my highest guaranteed sources of financial return,” she says.
Too many people look at their investments and their debt as two separate categories, she says. They’re thrilled with an 8-per-cent return on their investments while paying 20-per-cent interest on their credit cards.
“You’re making a negative spread,” she says. “There’s no good use in that.”
A “waterfall chart,” Ms. Premyslova says, ranks debt in terms of urgency, from credit cards to unsecured lines of credit to car loans, student loans and mortgages.
“Every dollar I pay off that credit card bill is, in a way, a guaranteed 20-per-cent return on that dollar by the virtue of not having to pay that interest next month,” she says. “The top end of that waterfall – that should be your number one priority.”
Canadians are thinking carefully about how to use tax refunds this year, according to a recent Toronto-Dominion Bank survey. Almost 80 per cent are expecting to receive a refund and about half are planning to save the money, up from 29 per cent last year.
More than a third plan to use their refund to pay down debt, up from about a quarter last year. And 25 per cent intend to invest their refund, up from 15 per cent a year ago.
For debt-free clients, or those with low-interest payments, the next priority should be maximizing contributions to registered plans such as tax-free savings accounts and registered retirement savings plans, Ms. Premyslova says.
If those accounts are topped up, paying down a mortgage is also a tax-sheltered option, she notes, because of the principal residence exemption.
Cory Papineau, a certified financial planner with Objective Financial Partners Inc. in Winnipeg, also says tax refunds should be used to pay off debt. But for him, the next priority should be building an emergency fund to cover three to six months’ worth of expenses.
“Having less debt just gives you that flexibility in being able to weather a storm a little bit more,” he says.
“Having some cash on the side is always good,” he adds, whether that’s to cover costs after losing a job, to replace a furnace, or to travel for a family emergency.
But Mr. Papineau warns against holding too much cash. Sitting on the sidelines often means missing out on growth, as no one can time the market.
Clients who are wary of an expensive and volatile market can invest the funds in several chunks, he says, but data show lump-sum investing is most effective.
“I always tell people emotion shouldn’t be part of your investment strategy,” he says. “Figure out your long-term plan, stick to it and ignore that noise.”
Seth Allen, senior portfolio manager and founder of Cadence Financial Group in Vancouver, is also against letting that money sit in cash, saying it’s the worst thing one can do.
“If you let it sit in cash, this thing called inflation – it’s like those moths that are in my closet that get into a couple of my suits over the winter – it eats that capital.”
For clients investing for the long term, asking if the market is too pricey right now is “kind of an irrelevant question to ask,” he says.
Clients who see markets hitting new highs should understand the S&P 500 has hit a new high on 1,200 days since 1957 – or on average once every 19 days, according to a report from Bloomberg.
“It is more common than the full moon,” Ms. Premyslova says. “If you’re constantly waiting for the market to not be at a high to invest, you’re never going to invest to begin with.”