Plan to use your tax refund wisely

Preparing an income tax return probably is not most people’s idea of a good time, but for many Canadians the task is made a little more enjoyable when they receive their tax refund from the government.

A lot of people don’t factor a refund into their financial plan and may end up spending it on a passion of their choice such as a vacation or some new golf clubs.

John Waters, vice president and director of tax consulting services with BMO Wealth Management, recommends the first you do when you get a refund is to review your tax return and make sure everything is correct and as expected.

Then it’s important to remember that a tax refund is not a windfall. “It’s just you’re hard-earned money that you have been lending to the CRA for nothing, so it’s important that you spend the money wisely,” Waters says.

Waters has some suggestions on how you may want to use your refund.

You may want to make a contribution to your Tax Free Savings Account (TFSA), make an early 2018 contribution to your RRSP to get growth, contribute to your children’s education through a Registered Educational Savings Plan (RESP) or put it into a Registered Disability Savings Plan (RDSP) if appropriate.

Other good options include paying off any high-interest credit card debt or loans, making a lump sum payment off your mortgage or starting or adding to an emergency fund.

“A good rule of thumb is to have at least three months’ salary saved as a safety net in the event of an emergency,” Water says. “Your emergency fund should be easily accessible and it should be kept separate from your day-to-day bank account, perhaps in a high-interest savings account or in a TFSA.”

While getting a rebate may seem like a gift from the Canada Revenue Agency it actually can be the result of some not-so-effective tax planning.

A tax refund typically occurs when the amount of tax owing on your return is less than the amount of tax withheld from your income during the year. Employment income is the most common type of income from which tax is deducted at source and therefore employees are the tax filers who are most likely to get refunds each year.

There are two main ways employees can reduce their tax at source.

The first is by making sure that the credits your employer uses to calculate your payroll deductions are up to date. The TD1 personal tax credit return sets out the personal tax credits you intend to claim when filing your tax return and helps determine how much tax is deducted each pay period.

If your personal tax credits have changed since you were hired you should re-submit the form so that taxes withheld at source can be adjusted for the tax credits beyond the basic personal exemption.

You also can apply to get your tax refund paid throughout the year on every pay cheque instead of waiting until after your return is filed by completing the T1213 request to reduce tax deductions at source form. On the form you indicate your regular RRSP contributions and other deductions and credits to be taken into account when your employer calculates the tax that will be withheld from your pay.

Some taxpayers, such as the self-employed, may pay their income taxes in quarterly instalments. The instalments are based on income over the last two years. If their income goes down they may end up paying too much and the instalments need to be adjusted.

If you are paying in instalments and do not pay the minimum there can be interest and penalty charges.

“The important thing to understand why you are getting a refund and then you can take steps to make sure you don’t end up paying too much,” Waters says. “You’ve got to remember that what you are doing is lending your money to the CRA for nothing, which is not solid financial management.”

Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.

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