Okay, so you’ve filed your income tax return on time. Now what?
Now we start planning to make you more money over the next year.
If you owed money on filing your return, congratulations! That means that you kept your money working for you to the maximum extent possible, rather than loaning it interest-free to the government.
Getting a refund means the opposite. A tax refund means that you did your patriotic duty by loaning the government money without interest for parts of the past year.
At the other extreme, however, is owing money because you failed to pay all your required quarterly tax instalments on time. This is even more expensive, due to the penalties and interest applied to late instalments, when you must pay on filing.
In fairness, both refunds and taxes owing on filing can arise from surprises during the year, unexpected amounts of income or deductions. Both can also be a result of good planning or from miscalculations.
If you receive a request from CRA to pay quarterly tax instalments, then seriously consider making those payments on time. Paying less than requested, or paying late, will result in interest and penalties, if you end up owing taxes at the end of the year.
For our clients, we do our best to calculate how much they will owe on filing the following year, based on estimated income from all sources, minus deductions.
If that calculation shows that the instalment request is too high, then we will suggest adjusting it so that the refund will be small.
If the calculation shows the instalment request is too low, then we recommend making only the instalments, but putting some additional money aside (earning interest throughout the year) for the expected extra amount that may be owing next year.
You can make that calculation yourself, if your advisor does not provide such a service, but I suggest you err on the side of caution, by paying slightly more than you expect to owe.
Putting your refund to work
Almost everyone I know prefers to get a refund when they file their tax return, as opposed to writing a cheque. Some use it as a forced savings plan, by having more tax money withheld from their paycheques (or paying extra instalments), so that they have this nice lump sum of money in the spring.
As we mentioned above, and explained below, that’s not the most effective financial planning. However, it might be the plan that works best for you. In that case, stick to it, but if you plan to have a refund, then please make sure you put that refund to work.
There are great things to do with your tax refund, like paying off high interest rate debt, making an RRSP contribution (if you are in a tax bracket where you can benefit), making an investment within your TFSA and, of course, spending some on yourself. (Be sure to take 10% of it and buy yourself somethin’ purty.)
Outstanding balances on credit cards should be attacked first, as these could be charging 16% or more. For anyone working full time, chances are a $1,000 RRSP contribution will save you between $280 and $430 of income taxes next year. Plus, that $1,000 will become $2,000 at some point in the future, after you invest it to grow and compound tax-deferred.
Getting your refund early
But, here’s a better plan for next year, for anyone who receives a T4 from an employer. You can request smaller tax withholdings on each paycheque, by showing extra deductions on your TD-1 form that you provide to your employer. These deductions include group RRSP, pension or your regular RRSP contributions, alimony paid, or credits such as the disability tax credit, age credit or large medical expenses.
By setting up a monthly contribution to an RRSP using that extra money, you can thereby reduce your taxes immediately, maximize your savings capacity and get your money working for you sooner.
It’s the classic triple threat.
David Christianson, BA, CFP, R.F.P., TEP, CIM is the recipient of the Fellow of FPSCTM Distinction, and repeatedly named a Top 50 Financial Advisor in Canada. He is a Portfolio Manager and Senior Vice President with Christianson Wealth Advisors at National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.