With all the talk of how people are spending their tax refunds (on this board and elsewher), there has been no mention of proper tax planning during the year. A tax refund is just us getting our money back from the government, money we have lent interest free through overpayment. How many people would invest in a product knowing the return is 0%? That’s what a tax refund is. I cannot find what the right statistics are, but I believe something like 80% of Canadians get a tax refund this time of year (can anyone confirm?). That’s telling me that 80% of taxpayers are paying too much tax during the year.
With proper tax planning, you can minimize your tax refund and increase your income during the year. Now small tax refunds of a few hundred dollars are nothing to worry about. But if you are receiving refunds in the thousands of dollars, you have been mismanaging your money.
There are tools that allow you to reduce the amount of income tax deducted from your pay during the year and realize that “refund” immediately:
However, if you are disciplined, taking your “refund” with each pay will allow you reap additional benefits.
For those that use their refund as debt payments, it would be more effective to use an increase in net pay to reduce your debt. For example, say your refund was $2400, which works out to $200 extra net pay a month. An extra $200 a month applied to your monthly debt payments would go further to reducing your long term debt obligation than a $2400 lump sum at the end of one year.
If your goal was to start a savings or investment account, those saving could have started earlier in the year, earning you some additional (albeit minor) income. In addition, if you invest in more volatile securities such as mutual funds, then spreading out your investment as $200 a month is less risky than a lump sum investment of $2400 due to dollar cost averaging.
Other things to consider are non-employment income, such as investment income, that is not taxed at the source, and requires you to pay the government at this time of year. If you find it difficult to save up for this expense, you can request your employer deduct extra taxes from your pay through the TD1 form. Of course, disciplined investors can take that extra pay and save it, earning a little extra interest before paying up to CRA.
With proper tax planning, you can minimize your tax refund and increase your income during the year. Now small tax refunds of a few hundred dollars are nothing to worry about. But if you are receiving refunds in the thousands of dollars, you have been mismanaging your money.
There are tools that allow you to reduce the amount of income tax deducted from your pay during the year and realize that “refund” immediately:
- Fill out a TD1 form. Everyone fills out a TD1 when starting a new job, but when you have life changing events, you can fill out a new one to reflect those events. For example, a new child will give you additional tax credits, reducing your tax payable.
- The TD1 is limited in how much tax relief you can get, since it only focuses on the tax credits from schedule 1 of your return. If you have major deductions in the year, such as large RRSP contributions or child care expenses, these will give you significant tax reduction during the year. However, to get these deductions recognized requires a bit more work on your part. You have to fill out form T1213 “Request to Reduce Tax Deductions at Source”. You mail this in to CRA along with supporting documentation. They send you an authorization, which you submit to your employer. This also has to been done annually.
- Group RRSP at source tax relief – I know at my work, the group RRSP plan allows me to recognize the tax benefits of the RRSP contribution in my pay. If you are part of a group RRSP, ask your employer if this tax relief is available.
However, if you are disciplined, taking your “refund” with each pay will allow you reap additional benefits.
For those that use their refund as debt payments, it would be more effective to use an increase in net pay to reduce your debt. For example, say your refund was $2400, which works out to $200 extra net pay a month. An extra $200 a month applied to your monthly debt payments would go further to reducing your long term debt obligation than a $2400 lump sum at the end of one year.
If your goal was to start a savings or investment account, those saving could have started earlier in the year, earning you some additional (albeit minor) income. In addition, if you invest in more volatile securities such as mutual funds, then spreading out your investment as $200 a month is less risky than a lump sum investment of $2400 due to dollar cost averaging.
Other things to consider are non-employment income, such as investment income, that is not taxed at the source, and requires you to pay the government at this time of year. If you find it difficult to save up for this expense, you can request your employer deduct extra taxes from your pay through the TD1 form. Of course, disciplined investors can take that extra pay and save it, earning a little extra interest before paying up to CRA.