-Discover how tax refunds work in Canada. -Learn how to avoid ‘intaxification’ and find better ways to spend your tax refund. -Find out how to reduce taxes at the source for additional income on payroll.
No one likes paying taxes, but everyone enjoys a big tax refund. The average Canadian receives just over $2000 as a tax refund, but getting a refund might not always be a good thing. On top of that, many Canadians tend to overspend when they receive their tax refund check.
In this episode, Carissa shares how tax refunds work, explores smart spending options and delves into the idea around why tax refunds may indicate poor financial planning with insights from CIBC resident tax expert Jamie Golombek.
Tax refunds are satisfying, but securing your financial stability would be smarter. So before you get tempted to spend your tax refund, tune into the episode to learn about your options.
Carissa Lucreziano: Welcome to Smart Advice, a podcast bringing you financial advice, investment strategies and economic trends. I am CIBC’s financial advice expert Carissa Lucreziano and today we're going to explore a question many Canadians have this time of year. What should I do with my tax refund?
Let's be real. Tax time probably isn't our favorite time of year. For many, the tax refund is what makes the sweat and tears all worth it. During the 2021 tax season, the government paid out 37.3 billion in refunds to 17.8 million Canadians for an average refund of $2,093. That's a good chunk of change. And it's one of the biggest paychecks some Canadians will receive all year. That direct deposit or check in the mail can feel like you just hit the jackpot. Our resident tax expert and my colleague Jamie Golombek calls this “intaxication”, the short-term euphoria of getting a tax refund.
Anecdote 1: So, I feel like for the most part, I've been pretty good about how I spend my tax returns. Although I can never really stop the feeling like I've just gotten a bunch of free money out of the blue
Anecdote 2: One year with my tax refund, I splurged on Toronto Raptors playoff tickets.
Anecdote 3: Something I've spent my tax refund on before is a very expensive TV, which had features that definitely are superfluous TV features, but which I personally liked.
Carissa: But with this extra money comes temptation and various possibilities on how you could spend it.
To get a tax refund, it's simple. If the taxes you pay during the year, usually as an automatic deduction on your pay, are greater than the tax that's payable when you file your return, you're owed a refund.
Here are some reasons why you might receive a refund. One is when you end up paying more tax on your total income than you need to due to various deductions that you can claim like childcare expenses, mortgage interest on investment properties, overpayment of CPP and EI contributions because you've switched jobs and started to pay them again from scratch. This is just to name a few.
Another reason could be because of RRSP contributions which are deductible from your total income, reducing income tax payable for the year in which the contributions are claimed. If the amount claimed on your tax return reduces the overall amount of taxes that you owe, and you've already paid these taxes through your pay, you might get a refund.
So what could you do with this windfall? Like any lump sum, you could use a tax refund for a number of purposes like paying down debt, investing, accumulating savings, or you could just spend it.
Let's unpack these options a little bit more. For many Canadians, debt repayment is a priority this year. In fact, CIBC conducted a survey on the topic of financial priorities, this topped the list for financial goals. Paying down debt is an obvious way to use your tax refund. There is no bigger drag on your bottom line and carrying high interest debt, which is typically credit card debt, compounding interest against you month over month. With the average credit card interest rate at 19%, it's important to remember that most investment gains will not offset what you're paying in interest on your balances.
A tax refund is also a great opportunity to put more money towards your investments, and can help you maximize the benefits of registered accounts such as an RRSP, TFSA, RESP or RDSP. Even a non-registered account that is taxable could be a good idea. Digital calculators and tools can help you make a more informed decision on which option may be best for you. Try our TFSA calculator and RRSP calculator available at cibc.com/smartadvice.
If your tax refund was a result of an RRSP contribution, it feels like a nice reward and almost like a pat on the back for making the contribution in the first place. As a result, you may be tempted to think of the tax refund from your RRSP deduction as free money. And we may forget that the purpose of RRSP contributions in the first place is to provide retirement income later in life. So investing your refund keeps the money in the future.
The case to invest your refund is even stronger if one of your goals is having sufficient income in retirement. You may not have seen as much as desired for retirement, or you may not have a workplace pension or you may expect to continue to have debt obligations such as a sizable mortgage payment.
All this being said there are years where other priorities come up that may require you to save your tax refund — and life happens. You might have a big purchase in the near future you want to save for. You might want to create an emergency fund to weather sudden expenses like a new appliance or a new roof. Having an emergency fund will also prevent you from cashing in your investments, allowing the growth to continue without any interruption. If you're saving for a down payment on a home, you can also direct your refund towards the new first home savings account or the RRSP home buyers plan.
We focused on paying down debt, investing and saving a tax refund. But in some cases, it makes sense to spend it. Say you're expecting a tax refund of $1,800 and also expect to pay about that same amount for a summer camp or vacation. By using your tax refund towards an expense you'd normally incur a few months later, you've eliminated the need to use your credit card or line of credit, and incur interest. And that's what we call smart spending.
Anecdote 4: I would say what I do with my tax refund has changed dramatically over the years. Ten years ago, I would have taken that tax refund and gone and bought myself a Marc Jacobs bag. Now I'm looking at putting that money away to save it to pay for summer camps for my children this summer.
Anecdote 5: I've used my tax refund to get an early start on my RRSP contribution for the following year.
Anecdote 6: What I do most years as I save most of it, I invest most of it: 80 to 90%. And the rest of it I spend on myself as a treat. And this year, it's going to be a trip to New York. So I'm really looking forward to that.
Carissa: Lastly, there's an argument to be made that getting a tax refund may not necessarily be a good thing. Contrary to popular belief. Jamie Golombek would say your tax refund is hard-earned money you've loaned to the government interest free.
Jamie Golombek: People love getting a tax refund. “This is free money.” “It's like winning the lottery.” And the truth is that's the opposite of the way you should feel. A tax refund is a sign of poor planning.
The biggest reason why people get a tax refund is because they’re employees and they have tax deducted at source by their employer. But what the employer doesn't know is that they have various deductions and credits that they ultimately get to do on their tax return that results in the refund. So, the most common example is an RRSP. People are making significant RRSP contributions during the year. And if they're not automatically done via payroll: lawyer does know about it, and you get a refund at the end of the year.
Other expenses like deductible childcare expenses, or things like deductible spousal support payments, charitable donations, all these things can give rise to substantial tax refunds. So, there's an easy way to avoid getting a refund next year, and that's by filling out a form. It’s a federal form that T-1213. Quebec residents have an additional form to file. By filing this form now, for 2023, you can actually reduce the amount of tax at source for the rest of the year. So instead of getting a refund when we talk next time next year, you're actually getting that money throughout the entire year to be increased a role every couple of weeks.
Carissa: For more of Jamie's tax tips, check out his website at jamiegolombek.com. Regardless of what you decide to do, it's all about what works for you, your ambitions, and your future priorities. Thanks for tuning into this episode of smart advice. To make sure you never miss an episode, subscribe or follow on your favorite podcast platform and visit us for more advice at cibc.com/smartadvice.