Why You Don’t Want an Income Tax Refund Next Year

Q: My friend was all but bragging about how big her income tax refund is this year and all the things she wants to spend the money on. I’ve filed my taxes, and while I won’t have to pay, my refund is just enough for a little splurge. I’d love to get a bigger refund so that I can go on vacation or buy a new car without borrowing any money, but I have no idea how to make that happen. I work hard and try to save, but it just feels like there’s always some bill I need a little extra money for instead. What can I do? ~Pamela

A: Most of us are excited to get a tax refund – it kind of feels like hitting the jackpot. According to Canada Revenue Agency (CRA) the average individual income tax return last year was $1,788. However, have you ever thought about where that refunded money comes from? It’s definitely not the same as winning the lottery.

Tax refund money is essentially an interest free loan you give the government each year; your refund is getting your own money paid back to you. While this kind of forced savings is a nice “surprise,” a smarter money strategy is to not let go of your cash in the first place.

Why You Don’t Want an Income Tax Refund

The reason you don’t want an income tax refund is because you could be making use of your own money throughout the year, rather than letting the government use it for free. If you often find yourself with more month than money, or wish you had just a little extra so that you don’t need to pay for essential living costs with a credit card, not getting a (big) tax refund might be the way to go.

How to Not Get a Big Income Tax Refund

If your circumstances in 2019 will be very similar to the past few years and you don’t owe CRA any money, consider having less income tax withheld by your employer. To do this, you need to complete the “Request to Reduce Tax Deductions at Source (T1213)” form from CRA.

If you make RRSP (Registered Retirement Savings Plan) contributions, have child care expenses or support payments, or have significant medical expenses, these are some of the situations that can trigger larger refunds. By accounting for expenses which are eligible for deductions from your income and non-refundable tax credits, you can top up your pay cheques (this year) with money that would have come back to you via a refund the following year.

A Word of Caution

One caveat, however, is that you must stick to your plan, or fill out a new form, because you don’t want to face an income tax bill the following spring. A household budget is the way to ensure you follow through with your plan and use the additional money effectively. An interactive budgeting spreadsheet will help you keep track of where you stand so that you know if you need to make any adjustments.

If You Get a Tax Refund, What Could You Do With It?

Not everyone receives an income tax refund, and many Canadians receive a smaller-than-average refund. However, regardless of the amount, spending money typically isn’t the problem. So what can you do with a “surprise” win-fall? From starting an emergency fund, to paying off bills, saving it for a vacation, investing it, or buying a special item – everyone has their goals.

When you consider what to do with an annual refund, most options could put your further ahead in the long run if done monthly instead. For instance, contributing to a savings account or investment on a monthly basis allows you to take advantage of the magic of compound interest.

If you invest in your child’s RESP (Registered Education Savings Plan), you’d even be eligible for the government grant of 20 per cent on the first $2,500 you contribute. That grant is in addition to any interest you earn, plus you can earn interest on the grant money.

Paying extra money towards debts each month is a form of accelerating your debt repayment. Many people do it with their mortgage, but it’s possible with any kind of debt.

Financial Calculators for Debt Repayment and Money Management

What Not to Do With an Expected Refund

Regardless of how much of a refund you may expect, resist the temptation to spend it before you get it. Once you see your refund deposited to your bank account, carefully consider how best to use it to help you reach your goals.

Another costly situation when it comes to your refund money is to accept the cashback option when you file your return with certain tax preparation companies. In exchange for receiving the money right away, the fee the company charges you can deduct a significant portion of the money you worked hard to earn.

The Bottom Line on Income Tax Refunds

If you reduce how much income tax you pay throughout the year, but then just blow the extra money on each pay cheque rather than put it towards your financial goals, stick with getting a refund. After all, forced savings is better than no savings.

Related reading:

How to Get the Most Out of Your Income Tax Refund

A Balanced Approach Can Mean Paying Off Debt and Investing in RRSPs

Top 5 Retirement Planning Tips (Spoiler Alert: The Lottery is Not One of Them)