September 5, 2017

Many Canadians count on an income tax refund as some sort of savings plan – at their own peril.

There are many reasons why it is not a good idea to overpay the government.   If you get a tax refund you are getting your own money, money that you have overpaid the government, refunded to you.  The government is not giving you a bonus or something extra.

In order to qualify for a refund you must have paid more money than you should have to the government for an entire year.  When you overpay the government you will not receive any benefit from interest accruing on your overpayment.  Not only that, but if you filed your taxes in April you may not get your money returned to you until May or even later.  In other words you overpay the government for a year and a half before your own money is returned to you.

If on the other hand you had invested the same amount of money in an RSP you might have received a whopping 1-2% interest, compounding all year, and a further tax deduction at the end of the year.

Let’s think about another possibility.  Let’s say that you have accredit card with a running balance of $5,000 calculating interest at 19% – your cost of paying simple interest is $950 per year.  You are out $950 per year while you are donating an overpayment to the government.  If it takes you a year and a half to get your overpayment refunded – you will have paid $1,425 in interest before you get your tax refund.

Imagine that you overpay your taxes by $1,500 each year, add that to the interest paid on the credit card (illustrated above) and now you are out $2,950 in one tax cycle from January of the preceding year to the mid-year point at which you finally receive your refund.

Imagine the amount of interest that you would then redouble by using your own money to pay off your debts then invest the same amount as you become debt free.