The Downside of Tax Refunds
May 18, 2021
Tax time can come with its many challenges, including navigating through a pile of paperwork to ensure you haven’t missed reporting any tax slips to CRA. While it feels rewarding to receive a tax refund, it is not the most efficient way of handling your finances.
When you receive a tax refund, especially a large one, it means you’ve lent money interest-free to the government. This money could have been invested during the year to earn interest and dividends or used to pay off debt and reduce your interest costs.
Let’s look at the following example using a tax refund of $5,000:
- Option 1: Invest in stocks paying 4% per year in dividends. The $5,000 you lent to the government could have earned you $200 in dividend income.
- Option 2: Pay down debt with interest ranging from 2 - 20%. The $5,000 you lent to the government could have saved you between $100 - $1,000 in interest (depending on what type of debt you have).
Whether you are still working or retired and receiving pension income, you can ask your accountant or advisor to calculate the optimal taxes to withhold on your income sources so that you neither owe taxes or receive a large refund during tax season.
You can change the amount of tax withheld from several sources of income, including:
- Employment income
- Pension income (both employer and government pensions)
- RRIF and LIF payments
If you do receive a refund for the 2020 tax year, make a plan of how you would like to allocate the money. You can consider paying down debt or depositing it into your investment portfolio. However, if you are like most people this year, you can also add your refund into a travel bucket for when we can all safely travel again, hopefully in the near future.
The views expressed are those of the author and not necessarily those of RGF Integrated Wealth Management, which makes no representations as to their completeness or accuracy.
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