Every year, many Canadians celebrate the arrival of a tax refund. It feels like an unexpected bonus, a pleasant surprise among all the bills from the holiday season. In reality, however, a tax refund simply means that you paid the Canada Revenue Agency (CRA) too much tax throughout the year. You get your overpayment back as a tax refund, but you’re essentially making an interest-free loan to the government.
Keep your money in your hands
Fortunately, there’s an alternative. For example, if you inform the government that you’ll be making non-payroll registered retirement savings plan (RRSP) contributions, they’ll authorize a reduction in the taxes that are deducted by your employer. You can use this additional cash flow in a number of different ways without making a dent in your take-home pay.
What you do with this additional cash flow depends on your situation and your goals. For financial security, debt elimination followed by wealth accumulation should be a priority over spending the “found” money. If you have debt, target the debt with the highest interest rate first, then your mortgage.
Great ways to use your additional cash flow
Reduce your debt
Pay down your credit card or consumer debt.
If you’re carrying a balance on your credit card, the high interest rates can erode your savings. Reduce the cost of credit by paying down debt with the highest interest rate first.
Pay down your mortgage more quickly.
Whether you have a traditional mortgage or a flexible mortgage with a line of credit, the value of reducing your principal sooner can be substantial. You can save thousands in interest costs and pay off your mortgage faster.
Review the terms of your mortgage contract and make use of all options available without incurring prepayment penalties.
Increase your savings
Maximize contributions to your RRSP.
Contributions and deductions that generate tax reduction can be directed back into your RRSP contributions for the next year. The earlier you contribute, the longer you can take advantage of the tax-deferred compounding of investment income.
Contribute to an RESP.
A registered education savings plan (RESP) allows a contributor to save money on a tax-deferred basis for a beneficiary’s post-secondary education. The earlier you begin contributing to an RESP, the more you’ll be able to take advantage of compounding investment income and maximize government grants. A contribution of $2,500 can earn a $500 grant per beneficiary each year until the end of the year in which the beneficiary turns 17, up to a maximum grant of $7,200.
Contribute to an RDSP.
A registered disability savings plan (RDSP) can assist families with planning for the long-term financial security of their relative with disabilities. Early contributions to an RDSP benefit from compounding investment income and can also benefit from available government grants and bonds.
Top up your TFSA.
Contributions to a tax-free savings account (TFSA) allow the investment growth to accumulate and be withdrawn tax-free. Because TFSA withdrawals are added back to your available TFSA contribution room in the year following the year of withdrawal, there’s flexibility in using the assets for mid-size to large purchases.
Establish an emergency fund.
It’s important to have easy access to emergency money to cover unexpected events, such as a job loss, illness, or major home repair.
By putting the money that already belongs to you back in your pocket — and without adding a single cent of extra cash — you can be on your way to financial independence sooner. Put one of these strategies to work.
Request to Reduce Tax Deductions at Source
It’s not just RRSP contributions that entitle you to lower taxes deducted at source. The CRA allows you to claim child care expenses, alimony, maintenance or support payments, employment expenses, and interest expenses and carrying charges on investment loans, among other tax deductions, to reduce the taxes you pay throughout the year.
The application process shouldn’t take you more than a few minutes:
1. Fill out the CRA’s T1213 form, Request to Reduce Tax Deductions at Source.
Note: Quebec residents must also complete form TP-1016-V, Application for a Reduction in Source Deductions of Income Tax, and file it with Revenu Québec to make sure they receive both federal and provincial source deduction relief.
2. Submit the form to your local tax office (call 1-800-959-8281 or visit https://www.canada.ca/en/revenue-agency/corporate/contact-information/tax-services-offices-tax-centres.html for the location nearest you).
It’s that simple.
The only disadvantage to this strategy? No more tax refund celebrations. The huge advantage? By lowering the amount of taxes that are deducted by your employer, you can put your money to work for you to eliminate your debt more quickly or increase your savings.
Contact your advisor for information about reducing your taxes deducted at source.
The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.