How to Pay Off Debt with Your Tax Refund

As the April 30 tax deadline approaches, many Canadians might be expecting a tax refund this year. In fact, if you’ve already filed your taxes, your refund might soon be on its way. While it may be tempting to use your refund toward a well-earned vacation, keep in mind that this sudden surplus isn’t really a bonus payment—rather, it’s the government giving your own money back to you.

In fact, if you’ve filled out your TD1 Personal Tax Credits Return form to reflect your current financial situation, it’s possible that you won’t receive much of a tax refund at all. But this is actually a good thing, as it means the government isn’t taking too much tax off of your regular paycheque. Rather than getting a big refund at tax time, you’ll have a bit more money every two weeks, or however often you get paid. But, if you do expect to receive a tax refund this year, your best bet would be using it to pay off debt.

Why paying off debt is better than investing your tax refund

Another popular use for a tax refund is putting it into investments, whether in an RRSP, a TFSA, or just a regular investment account. However, in many cases, you might be better off using that refund to pay off debt, especially if you’re carrying high interest debts, like an outstanding credit card balance. You’ll want to consider the rate of return—are the returns you’re hoping to see in the stock market this year going to be higher than the 20 per cent interest rate on your credit card debt? If not, your best investment would be to increase your net worth by paying off that credit card.

Your next best option? Saving for emergencies

Once you’ve paid off any high interest debts, and you feel that your debt is manageable, the next best thing to do with your tax refund is to put it in an emergency fund. Ideally, you’ll want to save up $1,000 to start, so you could cover the cost of an unexpected car repair or replacing a laptop, for instance. Over time, you can grow your emergency fund to cover three to six months of living expenses, which will provide a financial cushion and help you avoid debt in the event of an unexpected job loss or medical emergency. Saving for emergencies can also be a form of debt relief, by helping prevent unexpected costs from leading to unmanageable debt loads.

What happens if I can’t pay my taxes?

If you are carrying a lot of income tax debt, and aren’t able to pay it off, one solution that might help you is a consumer proposal. If you choose to file a consumer proposal, you would combine your outstanding income taxes with your other unsecured debts, including credit cards, payday loans, lines of credit and personal loans, into one monthly payment. A consumer proposal also freezes all interest charges on these debts. If you’d like to learn more, a Licensed Insolvency Trustee can explain all of your debt relief options to help determine if a consumer proposal might be the best solution for you.