Tag: Tax refund

Ten things to do with your 2013 tax refund

The tax filing deadline was extended this year to May 5 to address the disruption of the Canada Revenue Agency’s online services due to The Heartbleed Bug.  With that compliance requirement now behind us, attention now turns to managing tax refunds generated through the process.

Understanding that your clients may have visions of travel, retail and dining exploits dancing in their heads, here are some suggestions you can offer that will help keep their financial affairs on firm ground.

1.      Your RRSP

This will help generate another refund, but in the meanwhile is arguably an interest-free loan to the government until you file next year’s return. You could offset this by filing Canada Revenue Agency Form T-1213 to reduce tax deductions at source over the coming year.  By the way, the maximum RRSP contribution for 2014 is $24,270 (limited of course to 18% of the taxpayer’s earned income).

2.      Spousal RRSP

Rest assured that the spousal RRSP remains a useful income-splitting tool even with the advent of the pension-splitting rules, particularly if access is desired prior to age 65.

3.      RRSP loan paydown

If you took out a loan for your RRSP contribution, a prudent use of the generated refund is to eliminate or significantly reduce the loan balance now. The longer it remains outstanding, the more the non-deductible interest erodes the value of the proposition.

4.      Mortgage reduction

The sooner a mortgage is retired, the sooner there will be more in the monthly budget to devote to retirement savings. Whether mortgage and savings are addressed concurrently or in sequence, both contribute to your comfort level, financially and psychologically.

5.     Paying down discretionary non-deductible debt

Regardless of why it’s there, this kind of debt can often compound against us faster than we can accumulate savings. Eliminate such costly commitments as soon as manageable.

6.      TFSA

Not since the entry of the RRSP in 1957 has tax-sheltered investing been made so broadly and easily available. Consider also that a cash gift to a spouse that makes its way into a TFSA will not be subject to spousal income attribution rules.  The annual allotment of TFSA room for 2014 is $5,500.

7.      RESP

Especially for deposits that attract government grants, an RESP is great for education saving and income-splitting. As well, the systematic build should dampen sticker shock down the road when you see the amount due on your child’s acceptance letter.

8.      RDSP

Significant government support and tax benefits are available through these plans for families with disability issues. Be sure, however, to coordinate the RDSP within an overarching life program, of which financial management is of course a key component.

9.      Non-registered investments

Whether investing directly or using leverage, tax effect is a key influence in managing types and sequence of returns among interest, dividends, capital gains and return of capital. Have a plan within this non-registered world and dovetail it with other savings.

10.  Live it up … a bit

After all, saving is just spending-in-waiting – but try to keep it in balance.

Interest on RRSP loans: Payback for the payoff

The concept of the RRSP loan is firmly ingrained in our collective retirement savings psyche.  Whether to enable a current year contribution or as a means of catching up on past unused room, the process can be a catalyst that spurs on the savings habit.

Still, it should be kept in mind that this cannot be a permanent arrangement, but rather a temporary time-shifting tool.  As with any loan, there must be a plan for how and when that loan will be retired.  After all, it’s not free money.  

And at the core of appreciating the value proposition is the need to have a clear understanding of how interest on an RRSP loan is treated.  

Interest not tax deductible

Where money is borrowed and put to an income-producing purpose, interest payments are generally tax deductible.  This general rule applies to non-registered accounts, and rests on the potential for dividend or interest income, both taxed annually as earned.  

On the other hand, where a loan is undertaken in order to make an RRSP contribution, interest is not deductible.  To some that may seem unfair, but there is a quid pro quo logic behind this treatment, in that income and growth within an RRSP are not subject to tax.  

Thus there is an element of symmetry in this comparison: deductibility with taxable income, non-deductibility with tax-exempt income.

Bear in mind though that for either account type, the eventual drawdown will be taxable.  That would mean one-half taxation on capital gains when cashing out a non-registered account, compared to full taxation of money coming out of a registered account.

The combination of non-deductible interest with eventual taxable income should serve as reinforcement to retire an RRSP loan in a timely manner.  How timely?  Well, let’s look a little closer at the cost of that non-deductible interest. 

Servicing RRSP loans

To pay this interest, one must earn income, pay tax, then pay the interest.  Allowing for provincial variations, someone at $50,000 income faces about a 33% marginal tax rate.  It therefore costs this person $1.50 in pre-tax income to pay a dollar of interest.  

As a counterpoint, RRSP loans are always available at very favourable rates, often only a percentage point above prime rate, or even less.  With prime at 3% in early 2013, the current range is about 3.5% to 6%.

Beneficial though that may be, remember that the principal will eventually need to be returned to the lender, in addition to interest payments in the meanwhile.  Just as the interest is not tax-deductible, neither is the principal repayment. 

Hopefully this casts things in fuller light, making it clear that the pre-tax cost of making the contribution is essentially 150% of the amount borrowed in our example.  

Payback timeline

This kind of analysis is what underlies the common recommendation to use one’s tax refund to reduce RRSP loan principal.  Absent a real emergency arising between the time of contribution and tax refund, this should be the first and only priority for that refund. 

Beyond that, the borrower should endeavour to retire the entire loan within the year.  In fact, if it can be retired sooner then the monthly cash flow earmarked for repayment can instead be allocated directly into deductible RRSP contributions, progressively weaning away from the need for RRSP loans as the years pass. 

On the other hand, if that loan remains outstanding beyond the year, it then affects the person’s capacity to make later RRSP contributions, with or without the assistance of RRSP loans.  

Overall, and guided by these principles, RRSP loans can indeed be helpful in encouraging savings. In particular, a better understanding of the interest component can push a person further along that savings path towards realizing retirement goals.

Ten things to do with your tax refund

Well, with April 30 in the rear-view mirror, it’s time to turn our tax attention from filing compliance to refund investment.

Understanding that your clients may have visions of travel, retail and dining exploits dancing in their heads, here are some suggestions you can offer that will help keep their financial affairs on firm ground.

Your RRSP

This will help generate another refund, but in the meanwhile is arguably an interest-free loan to the government until you file next year’s return. You could offset this by filing Canada Revenue Agency Form T-1213 to reduce tax deductions at source over the coming year.

Spousal RRSP

Rest assured that the spousal RRSP remains a useful income-splitting tool even with the advent of the pension-splitting rules, particularly if access is desired prior to age 65. 

RRSP loan paydown

If you took out a loan for your RRSP contribution, a prudent use of the generated refund is to eliminate or significantly reduce the loan balance now. The longer it remains outstanding, the more the non-deductible interest erodes the value of the proposition.

Mortgage reduction

The sooner a mortgage is retired, the sooner there will be more in the monthly budget to devote to retirement savings. Whether mortgage and savings are addressed concurrently or in sequence, both contribute to your comfort level, financially and psychologically. 

Paying down discretionary non-deductible debt

Regardless of why it’s there, this kind of debt can often compound against us faster than we can accumulate savings. Eliminate such costly commitments as soon as manageable.

TFSA

Not since the entry of the RRSP in 1957 has tax-sheltered investing been made so broadly and easily available. Consider also that a cash gift to a spouse that makes its way into a TFSA will not be subject to spousal income attribution rules.

RESP

Especially for deposits that attract government grants, an RESP is great for education saving and income-splitting. As well, the systematic build should dampen sticker shock down the road when you see the amount due on your child’s acceptance letter.

RDSP

Significant government support and tax benefits are available through these plans for families with disability issues. Be sure, however, to coordinate the RDSP within an overarching life program, of which financial management is of course a key component. 

Non-registered investments

Whether investing directly or using leverage, tax effect is a key influence in managing types and sequence of returns among interest, dividends, capital gains and return of capital. Have a plan within this non-registered world and dovetail it with other savings.

Live it up … a bit

After all, saving is just spending-in-waiting – but try to keep it in balance.