Tax Tips for People Who Still Work

I’ve received a bunch of emails asking for personal tax tips because not everyone has a blog that’s making $30,000 a month. The biggest problem with giving out personal tax tips is there aren’t that many. If you work for employment income, then you are in the most screwed group in the world. Not only do you pay the most tax and have the least tax breaks, the government takes their money from you at source! When your employer gives you your paycheck, he has to withhold the estimated tax owning because Uncle Sam doesn’t trust you to pay the tax if you were given the full amount. If you’re still trading hours for dollars, keep these tax tips in mind.

Don’t Ever Get a Tax Refund

Getting a tax refund means YOU OVERPAID YOUR TAXES. It is the stupidest thing you can do. If you get a tax refund, it means you loan YOUR MONEY to the government for a whole year INTEREST FREE. The amazing thing is, most people are happy to get a tax refund. That just blows my mind! When someone tells me they’re getting XXXX amount back as a tax refund, my reply is, “I’m sorry to hear that.”

If You Do Get a Refund, Put It To Work

When you buy a RRSP (401K or IRA in the US), you trigger a tax refund because your employer withhold tax based on you not buying one. If you were in the 40% tax bracket, a $10,000 RRSP contribution will give you a $4,000 tax refund. Instead of spending this refund on toys, what you should be doing is putting the refund back into the RRSP.

Let’s assume you are in the 40% tax bracket and have $10,000 to invest into your RRSP. What you do is go to your bank and get a RRSP loan for $6,666.67, add in your $10,000 and buy $16,666.67 of RRSP investments. This will trigger a tax refund of $6,666.67 ($16,666.67 X 40%) which you will use to pay back the bank. Your cost will be 1 to 2 months of interest at most (interest on RRSP loans are not tax deductible). The bank can give you this loan below Prime because it’s extremely safe and they know they’ll be paid back with the tax refund.

With the above strategy, you no longer have a tax refund (well, you do but it’s going to the bank) but you’ve increased the funds you put into your RRSP by a huge amount. This will make an big different at retirement time. $10,000 a year at 8% for 20 years will turn into $494,229.21. However, $16,666.67 at 8% for 20 years will turn into $823,715.52. The formula on how much you can borrow so the tax refund matches the RRSP loan is:

Amount available to invest divided by 1 minus your marginal tax rate.
In the above example, it’s $10,000/(1-0.4)=$16,666.67

The above only works if you have not maximized your RRSP contribution limit ($18,000 or 18% of 2006 income, whichever is less). The majority of Canadian (and I suspect Americans as well) do not maximize their registered retirement savings accounts because they do not have the spare funds.

Buy Your 2008 RRSP Now

Most people are buying RRSP for 2007 because that is the tax year everyone is filing for. However, the smart people bought their 2007 RRSP last year and are now buying RRSP for 2008. When your employer deducts taxes from your paycheck, he does so based on the assumption that you will not be buying any RRSP investments. If your employer were to make source deductions based on you buying a RRSP, they would not withhold as much tax money. By buying your 2008 RRSP now, you can make your employer withhold less taxes.

Say you buy $10,000 of 2008 RRSP at the start of year and you’re in the 40% tax bracket. This will trigger a $4,000 tax refund when you file your 2008 tax return in 2009. However, you can take the RRSP receipt to the Canada Revenue Agency (Canada’s version of the IRS) 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 the 2009 tax season comes, you will have no refund and you will get an extra year of tax-free RRSP growth because you brought the RRSP at the beginning of the 2008 instead 2009.

If you just brought your 2007 RRSP and don’t have any money to buy your 2008 RRSP, then 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.

Make The System Work For You, Not Against You

Too many people let the tax system beat them up. They complain about paying too much taxes but are jumping for joy when the tax man returns money that they overpaid. The key to making the tax system work for you is by becoming financially literate. A financially literate person would know that if he gets a tax refund, he messed up.


36 thoughts on “Tax Tips for People Who Still Work”

  1. Stephen says:

    I used this method to sock away money when I was working a job before I became jobless 😀 It’s a great method that everyone in the job market should take advantage of because it forces you to save, but doesn’t impact your monthly cash flow because it’s money you wouldn’t have had anyway, loaning it to the gov’t instead.

  2. Terry Tay says:

    Great advice once again!

    I always hear people talking about a tax refund they got and they are so happy that they get to go shopping with it. Two things wrong there, like you said people shouldn’t be paying so much taxes over the year that they get a refund. Why give the government tax free loans? Second, why waste the tax return money on a shopping spree for things that you probably don’t need. Re-invest it and make it work for you.
    ~Terry

  3. …The amazing thing is, most people are happy to get a tax refund. That just blows my mind! When someone tells me they’re getting XXXX amount back as a tax refund, my reply is, “I’m sorry to hear that…”

    I never really look at this way until you brought it up. Great point John!

  4. Shawn Knight says:

    When I was younger, I always remember tax time, because the kids in my neighborhood always got new toys (a bike, video game, etc.) We lived in a low income area, so I just assumed tax time was a good thing, as people got free money from the government. Yeah, not quite so! 🙂

    1. Unfortunately, this is the poor mans savings plan.

      Most americans need to learn to “pay themselves first”.

      If you made the mistake of getting a refund, you need to reinvest it in your business, retirement, or at least pay off some debt.

  5. bryan says:

    Duplicate Content….Why didn’t you just link to last years posts for your latest installments of tax info.

    I guess it follows the same technique about yo recycling your topics that you talk about when you can’t come up with posts. Still alot of good info but nothing new? Even though its your writing. It just borders the line of stupid that I still read this blog.

    1. Verbal says:

      Just goes to show you that popularity breeds success!

      John can write anything and get attention. The rest of us have to rely on good content.

  6. After just experiencing my first tax time as an “adult” (ie. no longer a student with tax-free worries!) this kind of information is amazing. The best posts on your blog aren’t how to make more money, it’s learning how to penny-pinch like a king.

  7. The thing that kills me is how fast people blow away their tax refund. Instead of paying their debt, or investing, a lot of people see it as free money and simply waste it.

    1. It’s pretty amazing that people don’t realize it’s money they had already and they just loaned it to Uncle Sam for the better part of a year.

  8. John, i’ve also written about this strategy. Basically to obtain an RRSP loan only if the total refund is enough to pay back the loan. Here is the formula that I came up with:
    RRSP Loan = (RRSP Contribution x Marginal Rate) / (1 – Marginal Rate)

  9. Bryce says:

    I don’t know why you blame people for getting a tax return, what about PAYG Witholding?

    1. John Chow says:

      I don’t blame them for getting a tax refund. I’m saying it’s not financially responsible to do so. Do you enjoy overpaying for a car? Why would you want to overpay your taxes? I’ve heard people say they like to overpay so they can get a tax refund because it’s the only way they can save a lump sum of money to spend! Try and figure that one out.

      1. Bryce says:

        I wasn’t saying that getting a tax return wasn’t a bad thing; but in some places employers annualise the tax owed – so if you start a job near the end of the tax year, then obviously you are going to be owed tax that you didn’t need to pay. And in addition you have deductions, offsets and credits that can add to a tax return.

      2. Terry Tay says:

        That’s another thing I hear often. People asking their employers to take EXTRA tax off their checks so they get a bigger tax refund. WHY?

        Take the extra money and at the least put it in an RRSP each payday. This way you at least earn on your savings and you can deduct it from your income on your return.

        The government doesn’t give one single cent of interest on your “loan” to them.
        ~Terry

  10. Simon Lau says:

    that’s a brilliant idea to buy 2008 rrsps at the end of 2007 instead buying 2007 ones and then having the govt reduce how much the company takes away on each cheque.
    great post john

  11. Tax is a real great burden, I’m paying 12% tax here in Philippines knowing that money goes to nothing.

  12. Leon says:

    All good advice, but the tax refund part was an eye opener for me. Thanks John!

  13. Trevor says:

    Great Post John, i’ll be sure to tell anyone that needs tax tips that I know.

  14. Mike Huang says:

    What the heck!? I had no clue that if you receive a “tax refund” it means that you paid too much…

    -Mike

    1. Syed Balkhi says:

      lol why else will the government give you tax returns ?

  15. Varadinum says:

    Thanks for the advices John!

  16. This may only apply to the UK.

    But you don’t need to be earning $30,000 a month to setup for yourself? As soon as you start making any real money online then register as self employed (not sure about the US but you can do this in the UK easily). If it’s not a “living” wage then you can still find other part time work and treat that as a second income. Personally I just worked my ass off until it was a living wage. You can be self-employed in one job and an employee in another. Being self employed is not the same as forming a company and a self assesment tax return is much easier to complete than filing company accounts but you can still get many of the breaks that John talks about. I work as self employed because the limited liability of forming a company was of very little benefit to me compared to the extra accounting costs yet I still get tax breaks on travel, cars, lunch etc etc

  17. When someone tells me they’re getting XXXX amount back as a tax refund, my reply is, “I’m sorry to hear that.” – 😆

    1. RacerX says:

      I just blogged about that the other day. You really don’t want to give the government a no-interest loan for a year! It is really the fear of the IRS that has a lot of people doing that.

      Every year you have to review you W2’s!

  18. Great advice!
    When someone gets a tax refund it’s indeed a sign that he overpaid. But it is not always his fault, is it? People switch jobs, get promoted, get demoted, parental leaves — all that affects whether you overpay you taxes or not… and, of course it could be the other way around. 😯

    Cheers,
    Alex.

    1. Neil Duckett says:

      This is all good advice for the US or Canada, the tax system works very differently in other parts of the world.

      When i was in Australia i could get a refund based on claiming work related expenses incurred during that financial year, the governent then rebate me the tax paid on those expenses. That doesn’t make me financially illiterate.

      In Japan the tax system is very different and is based not only on your income but also the ward you live in, residence tax, this is deducted automatically from your salary after 12 months work. You pay tax the following year based on your earnings last year, an incentive to advance in your career otherwise you’re paying a higher margin of tax while earning a lower salary.

  19. Cody says:

    I got a tax refund my first year of filing taxes and thought it was great…until an accountant friend helped me realize that I was just loaning the IRS money. Now I list exemptions on my w-9 and save my taxes myself in a savings account. If I owe money, then I have it there….if not, then I get to pay myself my own refund…with interest!

  20. Hondo says:

    I have to admit, I used to be someone who loved getting that trusty old refund check. Not anymore! While I don’t look down on people who get them (and I know John doesn’t either) I think it’s great when people open their eyes and ears, and realize the truth.

  21. If you are an individual working for someone else, you should automatically put as much as possible into a 401K, and put the rest in a roth ira.( at the source).

  22. Robert says:

    I completely agree about the tax refund part. I can’t stand hearing people jump for joy when they receive a tax refund. Congrats! You just gave the government an interest-free loan! If you were a bank, you’d go out of business!!

  23. Taxes is unfortunately a pain in the neck and alsways will be I guess!
    I remember that when first I started with PPC for example my percentage was very high, till my accountant saw the amount of spendings I had (paying Adwords, Adcenter & YSM) then it when down a lot. I also hate that corrections are often only made at the end of the year!

  24. natespost says:

    This is TRUE….you would be surprised at the # of people who, when they get tax refunds, honestly think that means they had to pay NO income tax. If the govt made everyone pay at the end of the year instead of withholding, there would be another Boston tea-party.

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