Planning for a Tax Refund?
Refunds Reduce Pressure and Spike Savings
Your tax refund is the way to savings which pay you back – over and over again
At the risk of taking the fun out of tax season – stop laughing, keep reading – I suggest that you devote your tax refund towards savings. Okay, spend some, but allow me to make my case for making savings your first priority.
A tax refund is a kind of forced savings already. In essence, the taxes that were withheld over the course of last year were more than necessary to fulfil your annual income tax obligation. Once the full calculation has hit the books with the filing of your tax return, the government sends back that overage.
Commonly, for those whose income is mainly employment-based, this relates to RRSP contributions. Your employer would have reduced its withholding where it knew about contributions to workplace pensions and RRSPs, but it would not have known to do that for RRSP contributions you made outside of work. For example, at a 40% tax bracket, a $1,000 contribution to your own RRSP reduces your reportable income by that amount, so you have $400 coming to you.
As well, you likely made RRSP contributions in January and February, and can apply those contributions against last year’s income, giving you your tax break as early as possible.
Now let’s pause and think about the mechanics involved.
For those workplace RRSPs, some of your 2018 income is used to reduce your 2017 income, in effect paying last year’s taxes with this year’s income, which increases pressure on your cash flow from year to year, putting you in an especially difficult bind if you lose your job.
At a minimum, save the refund related to those first 60 days, whether it’s simply set aside in a Tax-Free Savings Account (TFSA) or as a further RRSP contribution. If it is the latter, your larger refund the following year will save you from playing catch up with your taxes. Supplement that with the refund from your other RRSP deposits and you’ll be ahead on both your taxes and your savings. Talk to your financial advisor to discuss all the mathematics of your personal circumstances.
MIKE MACDONALD is a Senior Wealth Advisor with over 25 years’ experience helping people achieve their financial goals.