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Jan 30, 2019

Two Thirds of Canadians Lend Money to CRA for Free1

by Julie Petrera

Julie PetreraBelieve it or not; A tax refund is nothing to be excited about. Essentially, a refund means you lent your own money, for up to 16 months—interest free—to Canada Revenue Agency (CRA). A tax refund is simply CRA returning your own money—late—and with less buying power than when you lent it to them.

Further, a hefty opportunity cost could be added to the equation: If you have any debt, the cost to you is actually the cost of your highest interest debt. For example, if you have credit card debt—the cost of that refund is approximately 20 percent. Therefore, the larger the tax refund, the more significant the cost. The average tax refund in Canada is about $1800. On a refund this size, the cost of that refund is about $200 in interest. This figure doesn’t include inflation erosion, which further reduces the value of your refund when you finally do receive it. And if you’re receiving a refund every year, these costs are piling up!

Why does this happen?

Refunds are the result of you having paid more tax throughout the year, than you should have. For employees, your payroll department assumes that all the money you make will be taxable, which is true until you do something to generate a deduction or credit. Reductions and credits reduce your tax payable, and the bill gets settled when you file a return the following year. Examples include Registered Retirement Savings Plan (RRSP) contributions, child care expenses, spousal support payments, employment expenses, interest charges on investment loans and charitable contributions.

How do you avoid this refund next year?

Do not stop contributing to your RRSP or your favourite charity but when you do, let CRA know that you would like to cancel the interest and inflation free loan contract that they have set up with you. Form T1213, which you can find on the CRA website, is used to demonstrate how your income will be reduced this year, and in return CRA will reduce your tax withheld at source by the amount you would be refunded next year, over the number of pay periods remaining in this calendar year. . You will begin to receive bigger pay cheques right away and continue to all year long, thereby transferring the purchasing power from CRA back to you. Form T1213 can be found using this link: https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/t1213.html

Put these “bigger paycheques” – to work for you.

Here are some suggestions on what to do with the $150 per month you used to lend the government.

•          Set up an automatic monthly RRSP contribution, using the extra funds being paid to you all year. This is systematic and easy (just like over-paying CRA was). Each November print a transaction history to prove you have been doing this and have your taxes reduced at source again. Additional advantages to the systematic RRSP contributions include dollar-cost averaging, the extra time the funds are invested and tax-deferred (compared to a lump sum RRSP contribution made at the end of the year).

•          Pay off debt starting with the highest interest-cost debt first. This will save you lots on interest all year long—compounded! (A refund of $1,800 would yield an additional $150 per month not-withheld, at a rate of 20% this would save you about $360 per year.)

•          Increase your monthly mortgage payments. Additional payments are applied entirely to the principal. You can be mortgage-free sooner and save on interest. An increase of $150 per month could save you almost $30,000 in interest over 25 years, which is $27,000 more than if you made that same pre-payment once per year with the $1800 annual refund. Also, the monthly pre-payments will enable you to pay off your mortgage about two years sooner.

•          Contribute funds to your child’s Registered Education Savings Plan (RESP). The monthly contribution will entitle your beneficiary to a grant of 20% (for the first $2,000 per year), and both the principal and the grant will grow tax-deferred.

•          Make monthly contributions to your favourite charity. This will generate a tax credit and help reduce your taxes payable next year.

•          And, if you prefer to save for a vacation—collect the interest on the savings yourself, instead of letting CRA do that, and at the end of the year you’ll have more money, which could mean a nicer vacation!

So, when thinking about what to do with your tax refund this year – consider reducing it!

 

Julie Petrera, MBA, CFP, CIM, FCSI

Twitter @petrerajulie

 

1https://www.canada.ca/en/revenue-agency/corporate/about-canada-revenue-agency-cra/individual-income-tax-return-statistics-2017-tax-filing-season.html

2https://www.canada.ca/en/revenue-agency/corporate/about-canada-revenue-agency-cra/individual-income-tax-return-statistics-2017-tax-filing-season.html

3Based on a mortgage of $500,000, amortized over 20 years, at 4% interest, with monthly payments