Tax refund: Source of pride or missed opportunity?
By: Donna Mitchell CFP
A tax refund sounds like a good thing, a feat to be proud of. In reality, it may represent a lost opportunity for building extra wealth.
Earning a refund means quite simply that you paid more than your share of tax in the previous year. In effect, you lent money to the government, interest free, instead of putting the assets to better use for yourself.
With a little planning, it's relatively easy for employed individuals to keep refunds to a minimum. (Self-employed people face special planning challenges as their business income and expenses may be less predictable.)
If you're a full- or part-time employee making regular contributions to an RRSP, for example, you may arrange to collect your tax refund "as you go" rather than wait a year or longer to claim the deduction. If you're making deposits to a registered plan through your paycheque - to a group RRSP, employee share purchase plan or pension plan - you're already benefiting from this strategy. That's because your employer has reduced your payroll tax to reflect these deductible contributions.
But if you're equally committed to making regular RRSP contributions via automatic transfers from your bank account, you can still apply to have less tax withheld from your pay. Here's how.
First, you obtain a T1213 form, Request to Reduce Tax Deductions at Source, from a Canada Revenue Agency (CRA) office or website, or possibly your advisor. You then submit the completed form, along with supporting documentation, to your local CRA tax services office. Once your request is approved, your employer can adjust the amount of income tax taken from your salary or bonus.
You may also qualify for a so-called tax waiver if you make other regular payments outside of your paycheque that will attract a tax deduction or non-refundable tax credit.
These include:
- child-care expenses
- spousal support (or child support under a court order or written agreement signed before May 1, 1997)
- certain employment expenses
- charitable donations and
- interest paid on investment loans
Generally, you must reapply for the tax waiver each year and provide updated documentation.
To minimize refunds, you'll also want to ensure your payroll tax deductions accurately reflect all personal tax credits you're entitled to claim for the year. Ask your employer for a TD1 form. Among the many credits listed here are amounts for dependants, caregivers, disability, tuition and transfers from family members.
Free up cash for other priorities
Having less tax deducted from your pay creates a number of opportunities to help you achieve your financial goals.
With higher take-home pay, you may be able to boost your regular RRSP contributions, as long as you stay within your RRSP limits. Or you could use the extra cash flow to start a savings plan outside an RRSP. Whether your savings are tax-sheltered in an RRSP or invested in an equity-based portfolio held outside your RRSP, it's possible to defer tax on some or all of your earnings for potentially many years. At these pre-tax rates of return, your investments compound even faster. Alternatively, you could use the additional cash flow to pay down a mortgage or other debt faster, and increase your net worth.
Accelerating the benefits of an expected tax deduction is one of the many potential rewards of sound tax planning. A financial planner who understands your individual objectives and situation can help you identify other strategies to pay as little tax as possible, as late as possible, so you can direct more money now to personal goals.
Advice from a professional is recommended before implementing any tax strategy.
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