Income Tax Refunds
Image courtesy of Mister GC. at FreeDigitalPhotos.net
Income Tax Refunds
Like it or not, it’s tax season! Personally, I actually look forward to tax season, because thus far, I’ve received a refund every year! But, as much as I like getting a return, it’s bitter-sweet.
What’s bitter-sweet about getting money?
The problem with getting a tax refund is it means you’ve effectively given the government an interest free loan. Rather than hanging on to that money throughout the year and using it as you please, you give it to the government. Assuming you get all the money you’re entitled to, that’s not such a big deal, but what really sucks is the potential earnings you’ve missed out on in the process.
In my case, I’m getting a tax refund just shy of $2500, which is more than I expected based on the previous year’s refund (I think it’s a combination of being in a lower tax bracket and making a larger contribution to my RRSP this year). I’m planning on investing most or all of this money immediately, but I’ve already missed out on some valuable earnings. To see just how much, let’s reuse my handy spreadsheet (courtesy of DrIp Investing) for calculating compound earnings:
If I distribute $2500 over 12 months and assume a compound interest of 7% (the historical long term growth rate of the stock market), I miss out on $93! Over 30 years, that means I loose $707. Now $93 is not a lot of money, and frankly, over 30 years neither is $707, but that’s besides the point. The point is not to just shrug off $100, because it’s a bad habit that will haunt you in the future. Consider how easy it is to spend $100 on a fancy dinner, theatre tickets, or a pair of shoes, and every time you do, consider you’re robbing yourself of $700+ in the future. If you do that 4 times a month for just 1 year, that’s >$33,000 of lost money 30 years from now! The power of compounding works both ways, it can earn you some mega-cash in the long run, but if you’re not careful, small actions now can have major consequences in the future!
On a happier note, that $2500, which I will promptly be investing will turn into nearly $20,000 in the future.
So what does all this mean?
It means, we (myself included) should try to avoid over-paying our taxes to maximize the power of compounding returns. In Canada, you can fill out a TD1 Form and submit to your employer to declare any tax deductions you might know about in advanced. You can also ask your employer to under-tax you a certain dollar amount every month if you anticipate you are paying too much (Form T1213). These can be particularly effective if you have multiple sources of income, or are expecting significant deductions for things like school/tuition or large RRSP contributions.