Tax refunds are good for most people. The simple reason is that left to our own devices, people don't save or invest their tax refunds. People tend to go the easiest route and spend.
The average tax refund is $2,950 a year as of 2020. Meanwhile, 74% of Americans get a tax refund. I'll consider you average for argument's sake. At today's typical savings rate of 1%, you're missing out on a whopping $12 bucks in interest income!
Why $12, and not $24? It's because you have to calculate the average balance of the year if you saved every $200/month payment diligently starting January 1st i.e. January $200, February $400, March $600 etc.
I'm definitely not a proponent of giving the government more money than they deserve, but missing out on $12 bucks in interest is something I can live with and so should you.
You have to ask yourself whether you have the discipline of saving that extra $200 a month, or using it to pay down debt. Most people are not disciplined enough to pay down debt and avoid buying junk.
This is why we have such massive debt problems in the first place! The government is essentially helping you “go broke to win big” by protecting 75% of American tax payers from blowing $2,400 a year without even knowing it.
A Simple Guideline For Tax Refunds
Want to figure out whether to get a tax refund or not? A good way to decide is to take emotion out of the equation and just use a simple ratio. If the expected increase in monthly cash flow is less than 10% of your monthly net cash flow, forget about it!
The extra money isn't going to make a difference in your lifestyle, but that extra nut at the end of the year will. Turn it around, most financial advisers recommend saving at least 10% of your yearly gross income towards retirement. For a small fee, the government is helping you get to that goal.
If you really want to know whether you'll be able to save your extra monthly income, buy a bag of your favorite cookies. Place them on your bedside table every night for 1 week, and see if you can avoid eating them. Now imagine a bag of cookies appearing every 2 weeks or every month for an entire year. Let me know how it goes!
All year long you condition yourself to live on less. Come year-end, you'll be happy you did!
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Related post: How To Pay Little Or No Taxes For The Rest Of Your Life
I’m definitely not a proponent of giving the government more money than they deserve, but missing out on $12 bucks in interest is something I can live with and so should you.
Getting 11K back is sweeeet! I’d be pumped! Good for you for paying down your loans.
Well I guess tax refund will be a handful as far as the majority of people concern, having too many sweets is not going to help our health, but we couldn’t survive without it either. Some grate thoughts and tips have shared by the users…. Most of them do make sense. Very useful information and thanks for sharing.
I love tax refund..If I have a 1 bag of cookies at my room I maybe eat once and keep the other and if I feel something that I want to eat sweets I’ll get it and eat it! It’s like saving money actually when you buy something that you want you’ll get a money from your savings and by the next day doing the same again. It is just about a “money” we don’t have to keep it.. That’s my thought actually..
I’m one of the guilty ones who not put enough money away for savings. I’ve gotten better, but definitely have a ways to go. With the recent financial crisis, it seems the government also has similar issues.
The source of the problem is that we are numb to the withholding out of our paychecks. It should be resolved at first.
found your site on del.icio.us today and really liked it.. i bookmarked it and will be back to check it out some more later
I received a $9700 refund one year. That was too painful, so I got less deducted from my monthly pay. Boo on me for not requesting it prior to that.
Part way through the year, I usually do a simulation on my old tax software to see where I’ll come in at for the year.
One thing that I’ve done a couple of years is immediately put my refund into my RRSP as a contribution when it comes in (say around March or April) and then top it up to my max sometime around October. Fortunately in 2008, I didn’t do that in April, I threw the whole thing in in October. Just sheer lucky timing.
.-= Single Mom Rich Mom´s last blog ..Do I REALLY need to work? =-.
Normally, I get a small refund, which is fine with me, but this year we’ve got the biggest deduction of all: a new house. We didn’t own it all of 2009, so I’ll have to see what the true numbers are next year and then adjust our withholding accordingly.
.-= RainyDaySaver´s last blog ..Fix-It Friday: Our Home Improvement Wish List =-.
Ah, OK, yes. I love the mortgage tax shield. Shields up! It’s a good feeling, especially if you can comfortably afford the house! Congrats!
I dont like the idea of overpaying the government then later getting the difference. There are lots of options out there for individuals who cant save like setting up an automatics allotment to mutual funds or a reitrement account.
I don’t like the idea either Jay, but I face reality. The reality is most people can’t save for cookies. And this year, I owe several thousand, and that just sucks.
.-= admin´s last blog ..Punctuality Breeds Credibility – Stop Being Late! =-.
As painful as it is to give Uncle Sam the interest free loan, it is the best thing for 90% of Americans. Lets face it, for most the money would be gone anyway. At least it is a forced savings mechanism that gives you an opportunity to be wise just once. What you do with your refund mainly determines if it is good for you. In my blog i discuss my debt free path.
.-= Dollars Not Debt´s last blog ..Do You Want to Be Wealthy? Three Very Simple Rules to Make You Rich =-.
Hum, interesting topic. I’ve always heard to make your refund as small as possible, and I do think it makes sense if you are good at managing your money and will use the larger paychecks you receive to increase your investing rather than your spending. That said, for most people, I think you’re right, FS; if they’re getting a $2400 ‘bonus’ once a year, it’s more likely that at least some of the money will make its way toward financially beneficial goals (put into an emergency fund or pay down a solid chunk of debt. Of course, most people reading your blog probably fall into the good financial manager category (or should once you whip them into shape), so we’re back to the first argument.
Short version: I can see either method working, depending on how your mind works.
.-= Roger´s last blog ..Net Worth Update: Another Month Gone =-.
I know there are penalties for underpaying taxes, but can you, for example, claim 10 allowances for the first 8 months of the year, and then have extra withholding held the last 4 months, giving you an 8 month interest-free loan?
.-= Daniel´s last blog ..Introducing The Samurai Alexa Ranking Challenge =-.
I’m sure there’s a way Daniel-san, but I have no idea how to do that!
I have co-workers who purposefully underpay, or ask for an extension b/c they owe too much in taxes. The penalty is less than the savings/earnings they get so it’s worth it to them!
.-= admin´s last blog ..Punctuality Breeds Credibility – Stop Being Late! =-.
I keep my W4 at a level where at the end of the year, I shouldn’t get a refund, nor owe the gubmint any extra taxes. I’m trying to tailor my lifestyle to be able to live on 50% of my takehome, and the other 50% goes towards debt prepayment.
If you are in an intense debt payoff mode, then this works great. If you have a ton of debt and don’t care about paying it off early, then by all means, let the IRS be your savings account.
Yeah, I couldn’t save if my life depended on it, it’s so tough to look ahead and not just live in the now! Thank god for tax refunds, but someday I hope to get over this difficulty of mine. :)
.-= Chris´s last blog ..Bridgestone Motorcycle Tires =-.
Huh, I’ve never thought about it that way – wise observation. The wife and I are using our refunds this year to travel to Turkey, and there’s no way we would have had the discipline to save up enough if the government hadn’t forced us. We would have *gasp* ended up using credit cards to make up the difference when the time to buy the tickets came around. So, I guess I should renounce my previous criticism of the gov’t geting an interest-free loan at my expense.
I do think though where the refund is particularly painful is when someone loses their job halfway through the year. That’s a time when the money could be the most useful, and assuming they don’t find a new job for a few months, their refund should be larger. Too bad there’s not a mechanism to access it sooner (not sure how early you can get those instant refund checks from places like H&R block?).
I don’t like a lot of things about the gov’t, but I’m willing to forgo an extra $12-24bucks of interest income a year. Keep that money away from me so that I adapt to spending less money a year all year.
Good point about unemployment halfway. However, hopefully one is used to the lower amount of income and has saved accordingly.
.-= admin´s last blog ..Riding Rocketships For Greater Success =-.
I’m not saying that people didn’t piss their money, but it seems to me that someone who pisses away a small amount each paycheck might do the same with a large refund.
Sorry, that should have been 1% for an extra 0.25 years. Sure, we may get our refunds on the same date each year, but that’s not relevant. Extra money that I would have received in a check on Jan 1, 2009 that I end up receiving on March 30, 2010, that money is delayed 1.25 years (and money that I would have received on Dec 31, 2009 is delayed 0.25 years), and could have been earning interest for that time period. The fact that I received a refund last year at the same time doesn’t effect the money that I could have made with this year’s money.
Well, I’ll shut up now – I’ve said enough on this topic :)
.-= Kosmo @ The Casual Observer´s last blog ..Bold Predictions for 2010 =-.
@Kosmo @ The Casual Observer
Believe it or not, there are some people who actually used their disposable income or tax refunds and invested in real estate and the stock markets in 2008 and got their face ripped off. I know everybody in the PF community are richer than ever before with this downturn, but investing cuts both ways.
Do you mind explaining me the calculation you are refering to? How did we get 2% for an extra 0.25 years? How did we get 2%? And if we always get our refund and pay our taxes on the same dates, isn’t that always a 12 month cycle? Thanks.
@ Sam – That makes sense, assuming that they haven’t changed (and also assuming that they would similarly piss away a refund). My assumption was just that there was surely SOMETHING the money could be used for that would yield more than 1%.
The calculation is also slightly off, as it assumes you’d get your refund on Jan 1. Get your refund on March 30, and it’s up to 1.5% (as you have the $2400 @ 2% for and extra 0.25 years)
.-= Kosmo @ The Casual Observer´s last blog ..Bold Predictions for 2010 =-.
@Kosmo @ The Casual Observer
Hi Kosmo – I’m talking about someone with all three: high CC debt, an auto loan, and a mortgage. If one has all three, I think there are bigger issues at hand and a shift needs to be made. Giving a credit addict more money to spend everything month is a sure fire way to piss it all away.
@Monevator
Ah, well.. you keep your cookies in an outhouse (yum), but the challenge is to keep the cookies on your bedside table. Good luck not eating one!
The refund comes about due to a convoluted tax structure we have here in the US. Deductions, exemptions, different marginal tax rates that give us all a headache. Flat tax is the way to go!
@Len Penzo
At today’s 1% savings rate, if you’re missing a $100 interest loss, that’s a nice $10,000 juicy refund a year! Still not that important if $850/month in extra month a month is less than 10% of your net monthly income though in my opinion.
.-= admin´s last blog ..Creating Powerful Friends: Samurai’s Alexa Ranking Challenge =-.
I’ve always chosen to receive a rather large tax refund every year and give the government a free loan precisely because it is a guaranteed windfall for me every February. Do I miss out on an extra $100 or so interest? Yeah. But really, is that enough to make a strong case for NOT getting a rebate? I say no.
The other side of the coin is the additional withholding forces you to live more within your means.
Best,
Len
Len Penzo dot Com
.-= Len Penzo´s last blog ..Black Coffee: My Favorite Blogs, Money News & Opinions #30 =-.
@ Monevatar – There are various tax rates based on incomes, as well as various deductions (exclusions from taxable income) and credits. Two people could make the exact same income and have a very different tax bill.
Government decides it doesn’t need the money? Now that’s funny :)
.-= Kosmo @ The Casual Observer´s last blog ..Member Exclusive: The Professional =-.
Hmm, I love the cookie analogy but I’m not sure it always holds. I’ve been known to keep cookies and the like in a secure outhouse to avoid eating them! But I’ve saved 30% of my income many years.
Where does this refund come from? Is it because in the us you all get taxed the same rate and then clawback later?
Or does the Goverment decide it doesn’t need the money? Okay, very funny you may think, but I got a tiny refund from my local council for that reason at Christmas.
“Going back to the title, let’s be realistic, if he has high interest credit card debt, a car loan, and/or a mortgage, he needs an entire make over …”
Not trying to start a big argument, but seriously, if he had a mortgage, he needs an entire makeover? Quite a lot of people have a mortgage …
I guess where we disagree is that you assume he’d piss it away and I assume he’d do something useful with it. Does it really take that much discipline to pay off extra debt each month? I set up a recurring payment with my mortgage lender to pay extra money each month. In order to stop the extra debt from being paid down, I need to actively remove this.
.-= Kosmo @ The Casual Observer´s last blog ..Ice Storm =-.
No matter what one chooses to do it will only serve to magnify and not makeover their already existing spending habits.
A) The person that spends more than they earn on consumables and racks up credit card debt to buy stuff will just buy more stuff if they adjust their taxes withheld and receive more take home money in their paycheck/earnings.
B) The person who invests their money wisely into their business, portfolio, etc. will just invest more if they adjust their taxes withheld and receive more take home money in their paycheck/earnings.
Therefore, the person in scenario A will just continue to make themselves worse off the more money they have in their pocket unless they correct their spending habits while the person in scenario B will just continue to accelerate their wealth creation.
.-= Credit Card Chaser´s last blog ..Are Credit Card Companies Evil if They Don’t Waive Fees on Haiti Donations? =-.