Blogs & Comment

What to do with your tax refund

Wondering what to do with your tax refund? You might want to read a post on the Independent Investor website about the Image Monster and your Savings Rate. The lead-in goes as follows:
Becoming rich is not determined by how much you earn or even by how you spend your money, but rather by how much you save. The amount of your savings is the key factor that determines how much you will manage to put aside next over the long term. In this commentary we identify the biggest obstacle to saving: envy or a need to impress others.
The best way to save your tax return is by paying down debt, starting with the highest cost debt such as credit cards and auto loans, followed by the mortgage. Consider also topping up your TFSA and/or RRSP. A $2,500 contribution to an RESP earns a $500 grant from the government (up to $7,200 per child).
Reducing taxes withheld vs. getting a lump-sum year-end
Many people say that getting a tax refund is a sign of poor financial management since you are loaning your money to the government interest-free. They instead recommend reducing taxes withheld at source by submitting forms TD1 and T1213 (Request to Reduce Tax Deductions at Source).
Chances are, you may ignore this advice! Even when people are told explicitly about their ability to reduce withholding taxes the vast majority simply chose not to, writes Professor Moshe Milevsky in Your Money Milestones.
The professor’s bookrefers to a study by two economists explicitly asking a group of taxfilers if they preferred their tax refund as a lump sum at the end of the year or in increments over the year. Seven in ten said they preferred the lump sum at the end of the year — even though they were giving up the interest or investment return that could have been earned from receiving the refund earlier. Seems irrational, the professor concludes.
But maybe Jonathan Chevreau has an explanation. He personally prefers to receive the tax refund as a lump sum at year end:
The problem with manoeuvres like asking employers to reduce tax deducted “at source” is it raises the likelihood you’ll have to pay tax come filing time, rather than getting a refund. Little unforgotten additional sources of income not taxed at the time of receipt, like year-end bonuses or non-registered dividends, tend to rear their ugly little heads.
In my own case I find tax on non-registered investments is just about cancelled by the RRSP deduction. Any other windfalls — perhaps from freelance work — may put you in the tax-owing category. So I look at modest overpaying tax throughout the year as a “margin for error,” with any refund a welcome bonus.