Gab

Gabriel Lalonde
August 22, 2020

Why a tax refund is actually BAD news

Towards the end of February, I noticed my neighbor struggling to take a large box out of his car.

As I walked over to help him, I saw that the box held a new top-of-the-line 65” Ultra HDTV. Peering into the back of his car, I spotted more boxes from the local electronics store.

“Big shopping spree, huh?” I asked.

He grinned and replied, “Aren’t tax refunds great? Free money!”

I did the neighborly thing and politely held my tongue. But what I really wanted to tell him is that he may have just made a huge mistake. Getting a tax refund is not a good thing — and it’s certainly not free money!

Each year, about 26 million taxpayers file tax returns in Canada. About two-thirds receive tax refunds annually.

So, let’s talk about three myths about big tax refunds … and how you can better plan your paycheck.

Myth #1: Getting a big tax refund is a great “backdoor” way to save money.

It sounds great in theory. You have more taxes taken out of your paycheck throughout the year. Then, after your file your taxes, you’re handed a nice chunk of change as a refund.

You may think that this strategy is an easy way to save money without employing any discipline on your end. You may have even promised yourself to use every cent of your refund to pay down debt and bump up your savings account.

The problem is that for most people, that isn’t what actually happens. The temptation to spend that windfall is just too strong! Fewer than 33% of people who get a refund use it to pay down any debt.

A better idea? Decrease your payroll deductions. Put the “extra” money into your RRSP or TFSA plan contributions. That’s a savings plan that could serve you better in the long run.

Myth #2: A big refund is the best refund.

We can all agree that receiving a check at tax time feels better than writing one.

But the truth is that the “free” money from your refund isn’t free. Getting a big refund spells an opportunity cost for you.

That’s your own money that the government has been holding for you. It’s not working for you. You’re not earning any interest or returns on investment (ROI) from it.

Myth #3: It’s not enough money taken out of my pay each month to make a real impact.

An average refund is about $1,500. If you received that money over the year and invested it, you could have earned over $200 (assuming a 7% return).

Even if $200 doesn’t sound like much, it can add up over the long term. Within five years, your opportunity cost could be around $1,000. Over 10 years, $2,000. Over 40 years, that’s at least $8,000 that you’ve lent the government interest-free.

Or, if you opted to consistently contribute that money to a 401(k), got an employer match, and had it invested, it would add up to lots more money in your retirement savings.

If you’re carrying some debt, you could pay it back faster with higher monthly income. Applying an extra $250 each month to your credit-card bills can make a big difference.

Bottom line: Don’t believe the hype about big tax refunds. Most people are better off using that money throughout the year to pay down debt or invest.

Understanding tax withholdings can be tricky, especially with the recent changes in tax law. If you’re not sure how to best adjust your withholding, the MDL Financial team is here to help. Drop us a line today.

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