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Sep 1, 2023

Why Getting A Tax Refund Is Worse This Year, And How To Prevent It

by Julie Petrera

A tax refund is never something to be excited about from a financial perspective. And learning that you’re expecting a tax refund this year is worse than usual. A refund means that the Canada Revenue Agency (CRA) is returning the tax that you over-paid. You effectively lent this money to them, interest-free, for up to 16 months. And now they’re giving it back—with less purchasing power.

Why Does This Happen? 

Refunds are the result of you paying more tax throughout the year than you needed to. For employees, your payroll department assumes that all the money you make is taxable, which is true until you do something to generate a deduction or credit. Deductions and credits reduce your tax payable, and the bill gets settled when you file a return the following year. Examples of these include Registered Retirement Savings Plan (RRSP) contributions, childcare expenses, medical expenses, spousal support payments, employment expenses, interest charges on investment loans and charitable contributions.

The Opportunity Cost Of A Tax Refund:

To calculate the opportunity cost of the refund, consider what you could have otherwise done with the cash that you lent to the CRA in the form of the taxes paid. For example, if you have debt, the cost of not applying this cash to the debt is equivalent to the interest rate on that debt. Depending on to whom you owe money, it could range from 7.2% if you are borrowing at the prime lending rate from your bank to over 20% if you have credit card debt. The cost to borrow money has significantly increased in the past 18 months; with the prime lending rate more than doubling from 2.45% in January 2022 to 7.2% in July 12, 2023. This more than doubles the opportunity cost of lending money to the CRA for free.

To put that in dollar terms, it depends on the amount of the refund you get or the debt you would otherwise have applied it to. The average tax refund in Canada is $2,092. On a refund this size, the opportunity cost of the refund not applied to debt is roughly between $150 and $420. 

The Real Cost Of A Tax Refund

The calculation above doesn’t include inflation erosion, which further reduces the value of your refund when you finally receive it. We are also in a historically high period of inflation, which further erodes the value of the tax refund this year compared to past years. With inflation of 6.8%, a refund of $2,0921 is only worth $1,950 in real terms by the time you receive it, reducing its purchasing power by $142. And if you receive a refund every year, these opportunity costs add up.

How To Prevent Tax Refunds

Do not stop contributing to your RRSP or donating to your favourite charity, instead let CRA know that you would like to cancel the interest and inflation-free loan contract that they have set up with you. The form is called T1213, and it allows you to demonstrate how you are reducing your taxable income now and request that your tax withheld be adjusted accordingly. The CRA will use the info you provide to reduce your tax withheld at source by the amount you would be refunded next year over the number of pay periods remaining in the current calendar year. This results in higher net pay immediately, thereby transferring the purchasing power and the time value from CRA back to you now rather than waiting until the following year when you settle your tax bill. 

Apply The Savings

Now that you’re keeping the extra cash in your hands, here are some ways you might want to apply it toward your financial goals:

  • Pay off debt starting with the debt with the highest interest rate first. This will save you on interest all year long—compounded! An otherwise refund of $2,092 put toward debt would yield an additional $150-$420 in interest savings.
  • Increase your monthly mortgage payments. Additional payments are applied entirely to the principal, which reduces the cost of borrowing and helps to pay down the mortgage faster. A mortgage-payment increase of $1752 per month could save you $30,000 in interest over 20 years and help you pay off your mortgage about two years sooner.3 (Contact your mortgage holder to see if this is an option).
  • Contribute the savings monthly to your RRSP* or Tax-Free Savings Account (TFSA). This can be set up to happen automatically. Additional advantages to systematic investing include dollar-cost averaging and the extra time the funds are invested and earning returns tax-deferred or tax-free, compared to making a lump sum contribution at the end of the year with your tax refund.
  • Donate to your favourite charity*. This will generate a tax credit and help reduce your taxes payable next year.
  • *If you make regular contributions to your RRSP or to a charity, complete and submit a T1213 form.

Donít Let It Happen Again

When thinking about what to do with your tax refund this year – think about completing at T1213 form and reducing it.

Julie Petrera, MBA, CFP, CIM is a certified financial planner. @petrerajulie

1      https://www.canada.ca/en/revenue-agency/corporate/about-canada-revenue-agency-cra/individual-income-tax-return-statistics.html

2      $2,092/12 months = $174.33 per month, rounded to $175

3      Based on a mortgage of $500,000, with 20-year amortization remaining, with an interest rate of 5.5%, and monthly payments: https://www.bankrate.com/mortgages/amortization-calculator/