Is the tax refund a good thing? It’s a question that spurred a great debate in February’s Knowledge Bureau poll when we asked tax and financial professionals whether or not the withholding taxes that lead to a tax refund should be reduced to help taxpayers save or pay down debt. Did the no side or the yes side win? You’ll be surprised by the results.
While the votes were split almost down the middle (58% no, 42% yes, from a total of 266 votes), the comments revealed that most agree about one fundamental concept: having taxpayers receive such large refunds means that the government is getting significant interest-free loans from taxpayers, and that’s not ideal.
The debate itself came down to a behavioral finance factor: taxpayers look forward to these returns and factor them into their financial planning each year, whether it’s the most strategic approach or not. So, reducing CRA tax withholdings means that many advisors have to re-align their clients’ way of thinking and their approach to money management – and they were divided on whether or not that could be effective.
Read on for more insight from February’s poll, starting with some comments from respondents who voted “no”:
Cindy outlined why having the extra cash flow monthly might be ineffective: “I wish I could say yes, but a lot of Canadians are not responsible enough to use the extra monthly cash in a beneficial way.”
Clare gave a succinct summary of why this is such a highly-debated issue: “Most prefer to have the refund, it has turned into a short-term savings account. Maybe we should encourage the CRA to pay interest on the refund. It would push the CRA to reduce the amount of taxes taken as they won’t want to pay interest, but recognize the amount as a true short-term savings account for the taxpayer.”
Joanne agreed, explaining that she’s tried to re-align her clients’ perceptions about the tax refund: “In spite of advice to the contrary, many clients still want the refund at the end of the year. Their idea of a reward at tax time or forced savings. I do, however, explain their options and the reasons.”
Mitzi-Lynne used an important example to highlight why she voted no: “I thought about this and I don’t think it would help, except in very rare cases. My clients all want that refund at tax filing time. If the deductions were used to reduce taxes paycheque by paycheque, the bills would still pile up, the bit extra on the paycheque would be spent on trivialities, nothing would get saved and at the end of the year there would be zero refund. Typically, my clients claim the Northern Resident Deduction. They could get this benefit paycheque by paycheque by putting it on the TD1, but they kick up dust at tax time because don’t understand that they already had that benefit, (and wasted it!) and you only get it once. I think that reducing the tax payments over the year would not benefit many people. It may be better that we try to do a bit towards saving them from themselves.”
Daniel stated that there could be repercussions if the government stops withholding too much tax: “I think the tax refund scenario is a win-win for everyone. The government gets the free use of our money for part of a year, and we get a forced savings with a lump-sum payout at the end of the year. If not withheld from paycheques, many taxpayers would spend it all as soon as they receive it anyway. And if the government didn’t get the free use of our money throughout the year, they would instead need to raise the tax rates. Would we like that any better?”
Frank said: “While a lesser refund would totally make sense, since it is the taxpayer’s money the government is working with, many people would not really benefit from it. Many taxpayers wait for that cash tax refund to make a purchase or go on vacation. All of these taxpayers who expect that refund would not save a dime during the year. Without this little bright light of the refund, they may not ever make their purchase, take their vacation, or worse, pay down debt.”
Tim explained how it may depend on the circumstances: “I would like to know what deductions and/or credits are being claimed to generate the $1,700 refund. Is this a one-time RRSP purchase in February? If so, the CRA had use of the refund for only about two months. Even if it was monthly contributions out of your bank account and not through work, average it out over the year and, really, how much interest are you losing? Is it from a year-end charitable donation? Again, not really much interest lost. If it’s a disability credit claim for a dependent or spouse, then, yes, the TD1 should be filled out and given to your employer to reduce tax withholdings.”
Alice pointed out that reducing withholdings risks that taxpayers will owe: “I would hesitate to recommend lowering withholding taxes, as it may create owing tax at the end of the year and this is very hard for taxpayers to deal with. I always find there are employees who ask to have more tax taken off each paycheque.”
Jo agreed: “I would hesitate to recommend lowering withholding, as I have worked with too many clients who depend on the ‘Rev Can savings plan’ and for whom actually owing would be a disaster. Indeed, when doing payroll, I always find there are employees who ask to have more tax taken off each paycheque. It is easy to look at this $1,700-plus as a ‘wasted’ opportunity but — especially for those taxpayers who don’t have that much discretionary income — this is the best way for a lot of people to accumulate some savings.”
Gaetan stated: “In my 35+ years as a tax accountant, the vast majority of my clients (90%+) want to see a refund from their tax return filing. The reason for this is that they see the refund as a tax-free “bonus” part of their income. They do not see it as paying too much in income taxes. Many of my clients actually rely on a tax refund to finance their vacations, home renovations, etc. If their tax deductions are reduced at source (from their paycheques), their standard of spending will simply increase accordingly. They see their refund as a type of ‘forced’ savings tool. Even after I explain to my clients that this means the government had their hard-earned money for more than 12 months, interest-free. My clients simply want a refund every year!”
Here are some comments from those who voted “yes” – which weren’t that different from many of the “no’s,” demonstrating why this is such a complex issue to debate.
Leanor indicated how addressing this issue with business clients opens up a whole different conversation: “You are all looking at the individual taxpayer, but what about the business taxpayer, who pays monthly corporate tax on the basis of the profit of the previous year end—business becomes slow so very little profit, but you have paid monthly to the CRA. Try getting that back in a timely period after you have filed your year-end—you will no doubt expect an audit as they hate to give up money paid in two years ago. Expect an audit which is very time consuming and a great expense to the business owner. CRA would give you penalties back to each month’s corporate tax bill if it wasn’t correct by their auditors.”
Ron explained that from a professional standpoint it makes sense, but he is concerned about the impact it would have on taxpayers: “Yes I think withholdings should be reduced, but there are just so many folks out there that use their tax refund as their savings account! And they will be happy with a big refund rather than the smaller amounts they would get each month, which would then just get spent! Many treat that refund much more wisely than they would with an extra few dollars on their paycheques!”
Prith said “yes,” but added that the CRA needs to introduce a more comprehensive assessment: “We need comprehensive assessment, it would make more sense. Then, the people who know they have high medical could use those to bring down their withholding.”
Doris agreed: “There are things that bring down your tax over and above the items listed on the TD1. If that was more comprehensive, it would make more sense. Then the people who consistently tithe, or know they have high medical, could use those to bring down their withholding.”
Pat said it would help seniors, in particular: “I suggest to seniors who get a refund that they should reduce it. Better to have the money monthly. I usually tell them it is better they get to spend their money than their heirs. Also, in BC, after the age of 55 we can defer our property taxes. It really helps!”
Heather pointed out how reducing withholdings demands professional advice: “Advisors, both tax and planners, should be working with their clients to update the TD1 each year. Another value-add that gets missed too often.”
Martin outlined the challenges, and offered a solution: “Yes, withholding should be reduced a little. It’s a free loan to the government. Having said that, however, many taxpayers would not reduce debt or save it, but consider it just more cash in their pocket to be spent. They just wouldn’t have to wait until the following April to receive it. A person can already ‘reduce tax deductions at source,’ if they make arrangements to make contributions to an RRSP and have their employer fill out the form. That way, it is a forced savings.”
Thank you to everyone who weighed in on February’s highly-debated poll question! This month, we’re changing gears and asking: “In your opinion, is it as difficult to envision life after retirement as it is to save for it?” Vote now!
Additional educational resources: As these poll results outline, getting the best after-tax results for a family is influenced both by perception and individual circumstance. Learn how to help taxpayers accumulate more wealth and discuss these complex issues as a DFA – Tax Services Specialist™.
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