Is A Tax Refund Good News Or Not?
David Christianson, CFP, R.F.P., TEP
Have you ever heard anyone complain about getting a tax refund?
Likely not, as it always seems like free cash in the mail (or now often by direct deposit), and who complains about “free” cash.
But is it “free” at all? Or does it actually have a cost?
Here are the facts. A tax refund is, at best, a return of your own money and at worst, an interest free loan that you have made unnecessarily to the government.
Sometimes it’s a result of good last minute planning, like a large RRSP contribution at the deadline. On a rare occasion, the cash from the government is a grant or refundable credit that is not a result of you overpaying. That’s a little different, and there’s not much you can do about that.
However, my suggestion in this article is that you can do much better with your money than leaving it with the government throughout the year. You could be using that money to pay down debts on which you are paying interest, making a larger RRSP contribution or investing the money in your name rather than theirs.
Don’t get me wrong, I love cash in the mail as much as the next fella. I also realize that for many people, overpaying income taxes throughout the year is the most effective - or the only – method of accumulating cash.
If that is the case for you, and if you put the money to good use when you receive it, then carry on. Don’t let my theoretical talk throw you off an effective tactic that is working for you. However, here are some other ideas you might want to consider.
First off, determine why you are getting a refund. For most people it is because they receive salary from an employer, and more money is withheld than necessary. This is often the case with summer students and other seasonal employees. The tax tables that determine withholding tend to assume that you are going to earn that amount through out the year, and calculate the deductions accordingly.
For example, if a summer student earns $12,000 at a rate of $3,000 per month, withholdings are closer to those for a person expected to earn $36,000 in the year than someone who is expected to pay no tax.
In this case that summer student will likely get all the tax back when filing, once tuition and education credits are factored in.
Similarly, if a person works full time and contributes to an RRSP monthly, they will likely receive a refund equal to 27% to 44% of the contribution. On the other hand, if a person belongs to company pension plan, this will likely be reflected on their TD1 (the form for credits used in determining tax withholdings), resulting in lower monthly withholdings.
This approach means that the person with pension contributions receives the tax refund throughout the year in the form of higher take home pay on each paycheque.
If you habitually receive a refund each year and like this other approach better, start by ensuring you have put all available credits on your TD1. Then, using CRA form T1213, apply to the CRA to give permission to your employer to deduct less tax than would otherwise be required. On this form, you can “pre-claim” RRSP deductions, child care expenses, support payments, employment expenses, interest deduction on investment loans, donations, rental losses and any other deductions you might have to be factored in when determining the amount of your monthly withholdings.
At the same time, develop a plan to use that monthly money to further your personal financial goals. It might be to accumulate a cash reserve (and maybe put into a TFSA), pay off credit card balances, pay down loans or increase your monthly RRSP contributions. It might instead be to save for a trip or a special purchase.
No matter what your dream, write down the plan, with a specific monthly amount, and stick to it.
In the next few weeks, we will look at the science of income tax quarterly instalments.
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If you are getting a cash tax refund, please go through the same financial planning process – look at your current situation, assets and liabilities, re-read your written goals, examine that gap for opportunities and challenges, review your alternatives, then make a decision and implement it.
Step 6 of the process is periodic review, to make sure you stay on track.
What better way to celebrate the first day of spring than reaching some important goals!
David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc. His column, ‘Dollars & Sense’ appears Fridays in the Winnipeg Free Press.