When it comes to taxes, I have married two total separate viewpoints.
I absolutely think taxes are a good thing. They fund much-needed government spending and statistics show the happiest countries in the world are also taxed at higher.
There is more to the story than those two sentences, but I think taxes are a good thing.
That being said, I also don’t want to give the government more than they are asking of me. I don’t mind paying my fair share, but I also want to make sure I’m keeping what is mine.
That’s where the tax refund comes in. If you overpay, the government makes sure you get it back.
Not a bad deal, right? You still get to keep what’s yours!
Not so fast. As with everything, there are two sides to the story.
The IRS reported in July 2020 that the average refund was $2,741 for the 2019 filing year. That’s a lot of money to be given all at once!
Being given a lot of money once a year is a lot of fun. The only problem is that you aren’t being given anything.
You are being given back what is yours in the first place.
Imagine what you could do with all that money divided up into your paychecks every year and then automatically deposited into an actual investment account.
It could even give you a bit of breathing room in your budget. But those aren’t the only reasons why a tax refund isn’t exactly something to get excited about.
Here are four more reasons.
1) A Matter of Interest (Rates)
No one is ever going to tell you that a standard savings account is a good investment.
The average rate for a savings account these days is 0.07%. That is seven-hundredths of a percent. It would take over fourteen of those to equal 1%.
It’s not a very good return. At. All. And with the Federal Reserve keeping interest rates low for the foreseeable future thanks to the COVID-19 pandemic, it’s not going to get any better.
That’s why we all seem to know that a savings account is not going to make you rich off investing in it.
Do you know what the interest rate is on your tax return being held by the IRS?
Ok. You get the picture. “Investing” with the IRS provides the only rate of return lower than a bank account outside of “Your Mattress” Bank.
You are literally earning nothing on the money that you’ve overpaid in taxes.
And if you factor in the cost of the money you could have earned in interest by investing—the opportunity cost—your earnings are actually a negative number. Stinks, doesn’t it?
I know it’s becoming a cliche at this point, but it’s literally an interest-free loan to the government.
2) What Happens When You Overpay?
Overpaying on anything is kind of an inconvenience. If you go to the store and they charge you too much, what do you do?
Some people will fight tooth and nail for the money they are owed. Most people will say something in a nice way and get their money back.
Very few won’t care at all.
The point? We all want our money back. And we want it back as quickly as possible.
We don’t wait until the first part of the year to get our money back.
So why do we take the opposite approach with the government?
We actually get excited about the government giving us our money back next year that we’re giving them now.
There is no rhyme or reason for it. It’s the one area where we overpay and don’t care about getting our money back right away.
3) Your Debt vs. Their Debt
If you’re like most Americans, you have some debt that you need to pay off.
The average revolving credit card balance for American households in 2020 was $7,027 according to NerdWallet.
You may have more debt than that. You may have less than that. Do you know how much debt the United States Government has?
$27.78 trillion! Let’s put that in actual numbers for you.
That is the current amount of U.S National Debt. Regardless of your views on Modern Monetary Theory, that is a lot of money to hold as debt.
Our federal debt has skyrocketed over the past 20 years. In 2000, the federal debt was just over $5.5 Trillion. In 20 years, our national debt has grown five times the amount it was.
The U.S. Government has added some great services that we need to spend money on, but we have not found a way to pay for them.
The bottom line is that it is better to leave the extra money you gave the government in your hands instead of theirs.
4) How Much This Can Save You
Imagine this for a minute.
Say you have a credit card that has a $3,000 balance. You bought something at the beginning of 2020, and you are waiting for your tax return to pay it off.
You’ve been paying the minimum of $60 (2% of the balance) each month since your first bill arrived in February 2020. The interest rate on this card is 12%—an average interest rate.
If you are paying that minimum for 12 months, and pay the balance off in February of 2021 when you receive your tax return, you will have paid $365.72 in interest.
Now, say you weren’t giving the IRS an interest-free loan. Dividing that amount by 12 would give you an extra $260 a month.
Having the same balance and interest rate, let’s combine that $260 a month with your $60 minimum payment.
Paying $320 a month to that credit card, you would now have the card paid off in just 10 months and pay $165.95 in interest.
By not giving the IRS free money, you’re saving yourself two months and about $200 in interest. Not bad for only having to make a simple adjustment!
Put This Into Action
Now, this wouldn’t be Atypical Finance if I told you this was the only way, but I do want you to highly consider it.
What could you do with an extra $200-$300 a month?
Would you be able to invest in your future more? Would you be able to pay off your debt quicker?
Does that extra money give you some much-needed breathing room?
The choice is yours, but if you want to make some changes, the best way is going to be to change the number of allowances on your W-4 form with your employer.
You can also do this for your State income tax refund as well.
Talk to a tax professional to find out exactly how much you need to claim on your W-4 form.
You can also check out my guide here on how to do this yourself as well as what you can do to get the best of getting a refund while not leaving your extra money with the IRS.
However, it’s best to consult a professional tax accountant before doing this.
I touched on this a bit, but why go through the trouble of this at all?
Well, $2,741 is a lot of money! There is a lot you could do with that money on your paycheck instead of waiting to be returned to you by the IRS.
Think about what an extra $200-$300 every month would do for you. You could:
- Pay off your debt faster
- Take a family vacation
- Build up your emergency fund
- Give yourself a little breathing room
- Give you the ability to switch careers
- Allow you to go out to eat a little more
- Give more to your church or charitable organization
- Start a side hustle
- Invest in a 401K or Roth IRA
- Work on paying off your mortgage faster
This is just the tip of the iceberg. There are a ton of things that you can do with the extra money you are giving the IRS.
Take a look at what you are giving to the IRS free of charge. If it makes sense for you to receive that money on your paycheck instead of waiting around as a yearly amount, make some adjustments.
Remember, each thing that you could do with that extra money is a WHY for getting a bigger paycheck now, rather than continuing to let the IRS hold your money for you.
Make some changes, and watch your financial life continue to change for the better.