Today I sent off my 2005 tax return. I had to pay of course, which is a good thing. I would be upset if I had a refund. Why? Because a refund would mean I overpaid my taxes and the government had the use of my money interest free for a whole year. Yet, thousands of people are doing back flips when they get a refund. It’s amazing how the government can spin things to brainwash people into thinking a refund is a good thing. If you properly plan your taxes you should never get a refund.
Best case scenario is you don’t have to even make tax installment payments and just pay your tax bill when you file your tax return. Then you have the use of the government’s money for one full year interest free. Put what you would pay for tax into a short term cash account and make some money off it. Then when the tax time comes, take it out, pay your tax and keep the interest earn. However, employees can’t do that because their company withholds taxes from their paycheck. Here’s a little financial trick you can do to get more money out of each paycheck.
Most people buy their RRSP (401K or IRA in the US) at the end of the year in order to reduce their taxable income and get a tax refund. When your place of work deducts income from your paycheck, they do it based on the assumption that you will not be purchasing a RRSP – that is why you get a tax refund. If your employer deducts from you paycheck based on you buying a RRSP, they wouldn’t withhold as much – that gives you more money in your pocket for each paycheck. How can you do this? By buying your 2006 RRSP now instead of in 2007.
Say you buy $10,000 of 2006 RRSP now and you’re in the 40% tax bracket. That will trigger a $4,000 tax refund when you file your 2006 tax return in 2007. However, you can take this RRSP receipt to the CRA and get a letter from them that tells your employer to make source deductions based on your gross income less the amount of your RRSP contribution. This will give you about $334 extra per month ($4,000 divide by 12). When tax time comes in 2007, you will have no refund and you will get an extra year of tax free RRSP growth because you brought the RRSP in the beginning of 2006 instead of 2007.
Now what if you don’t have the money to buy your 2006 RRSP because you just brought your 2005 RRSP? In that case, borrow the money from your bank to buy it. Take the RRSP receipt to get the CRA letter and use the extra money you get from each paycheck to help pay back the loan.
This is how you make the system work for you, instead of against you. The next time you hear someone say they got a tax refund, you should say “I’m sorry to hear that.”