Money Management Newsletter: Taxes
and Estate Matters
As the warm weather arrives, has your tax refund?
If not, perhaps it's a good thing as it gives you time to think about why you're getting one, and what to do with it when it arrives.
Some people don't mind stepping over the shortfalls of a having a tax refund and look forward with glee to its arrival... A sort of forced savings, "I'm going to buy a new barbeque", type of thing.
There could be several reasons why you're getting a refund however the most likely reason is that you overpaid your income taxes during the past year. This means you're been lending money to the government without receiving any interest. If you're not happy with that, the best way to stop it recurring is for you and your employer to review your TD1 form and check its accuracy, with the possible result of lowering the amount of tax deducted from your paycheque.
Another possible reason for a refund is because you made an RRSP contribution. If you borrowed for the RRSP then the refund should be used to reduce that debt. Canada Customs and Revenue (CCRA) doesn't allow for the deduction of interest on an RRSP loan so the faster you pay it off the better. If you made the RRSP contribution from your own resources, consider using the refund towards your current year RRSP contribution, as the earlier you contribute the more you will benefit from the effects of compound interest.
If you plan on making regular RRSP contributions throughout the year you can receive an immediate tax refund prorated over each of your pay periods. This is done by submitting a "Request for Reduction of Tax at Source" to CCRA for approval. Once approved CCRA will forward to your payroll department an authorization for an income tax reduction on each of your pays to total your expected refund for the year.
Regular RRSP contributions throughout the year are also a great way to eat away at any unused contribution room you have.
Other areas deserving of your refund are credit cards, especially the retail cards like Sears or Canadian Tire. Check out how much interest you're paying on them. Retail cards are 28.8%, a king's ransom for the convenience especially if it was screwdrivers or lipstick that racked up the debt.
One way to view this type of expense is from the perspective of the money in your wallet. The cash used to pay that interest is money you've already paid taxes on. So, If you're in a 40% tax bracket you would have to earn about $1,700. before taxes to clear that debt. - expensive screwdrivers and lipstick?
Using the same logic, but in reverse, consider applying a $1,000 yearly tax refund to reduce your mortgage. Huge savings are found. By making a $1,000/yr reduction against a 6%, $100,000 mortgage amortized over 25 years your savings amount to $22,331 lessening the amortization period by 5 1/3 years.
Now that you've taken 5 1/3 years off your mortgage, consider the impact of diverting those saved mortgage payments into a savings program. The monthly principal & interest payments on the mortgage example given would have been $639.81. Depositing this amount monthly into a high yield savings account and assuming a 3% annual rate of return would give you about $44,400 over the 64 month time frame. You now have double savings - not making extra payments of $22,331 on the mortgage and building a $44,400 nest egg through the simple process initiated by applying a $1,000 tax refund to your mortgage.
If you have children, also consider using your tax refund
to start up an RESP, provided your children meet the age requirements.
The government will give you an extra grant of 20% on your RESP contributions
up to a maximum grant of $400 per qualifying year.
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