MANY of the Canadians who file their tax returns by next Tuesday will be receiving refunds. Many have received them already.
As a financial adviser, this always disturbs me slightly. Those people have provided an interest- free loan to the government since the money was either withheld from their regular paycheques, through other withholdings, or sent to the government as quarterly instalments.
In theory, that money could have been used more profitably by the taxpayer through the year. If the person owes money on credit cards or consumer loans, those tax withholdings might have been reduced and those tax dollars used to save interest costs, if it is clear a refund is going to be produced. But the practical adviser in me knows many people prefer a refund to a balance owing, and the extra income tax withholdings really act as a forced savings plan, accumulating money that would likely be squandered if only received in small amounts through the year.
So, today’s column has two purposes — to encourage you to make the very best use of any refund you are receiving, and to also consider how you might improve your financial situation more by keeping your chips on your side of the table longer, by putting them to work for you throughout the year.
Let’s talk about that refund.
The first priority should be any high-interest debts, such as outstanding credit card balances. Interest rates of 18 per cent or higher are still not unusual for credit cards, even in today’s low-interest-rate environment. Paying that much non-deductible interest is senseless, so these debts have to be attacked first, either with the tax refund or any other source of extra cash. Make such debts your first priority.
The next choice is likely any debts that are charging interest well above the expected rate of return on investments. By this, I mean loans at six to eight per cent or higher. (As part of this analysis process, of course, also look for ways to renegotiate those high-interest-rate debts or credit cards into a low-interest line of credit.) When you get to debts that are manageable and have interest rates close to prime, or mortgages in the range of three per cent or four per cent, the alternatives such as RRSP contributions become very attractive.
Using your tax refund for an RRSP is an awesome idea, depending on your income tax rate. If your taxable income is $45,000 or higher, then your marginal tax rate will be 35 per cent or higher.
This means each $1,000 contributed to an RRSP will save you $300 or more in taxes when you file next year’s tax return, and you will have the entire contribution amount invested and earning toward your retirement.
If you have kids, another way to get more money back from the government is to make a contribution to an RESP, a registered education savings plan. The first $2,500 per year contributed per eligible child will result in a 20 per cent government grant, deposited into the RESP and added to the money growing for future education expenses.
For people whose finances are in great shape and the tax refund is really a bonus, then definitely consider using some of it for a splurge, like next year’s winter vacation. (But you probably already thought of that, if you are that well-organized.) Now, let’s look at how you can accomplish those strategies more effectively — and sooner — by paying the feds less money throughout the year.
If you’re paying quarterly tax instalments, you can pay less than requested. However, this runs a risk, because if you end up miscalculating and owing tax at filing time next year, you will pay both interest and penalties. This is not worth it, so only underpay your instalments if you know you will have a refund by paying them. This could happen if you have had an unusually high-income year, resulting in a request for instalments that is not accurately based on the current year’s income.
With paycheque withholdings, you can file a CRA form T1213, Request for Reduction of Withholdings at Source. On this, you provide your expected income and deductions, which could be for RRSP or pension contributions, employment expenses, alimony or deductible interest on investment loans, among other things.
If the CRA agrees you qualify for smaller tax withholding amounts, they will authorize your payroll officer to reduce these.
Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice. David Christianson, BA, CFP, R.F.P., TEP, is a financial planner, adviser and vicepresident with National Bank Financial Wealth Management and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.