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!
Track Your Net Worth For Free
The other action item wealthy people do is track their net worth. You can only truly optimize your wealth if you know where all your money is going! Sign up for Personal Capital, the web's #1 free wealth management tool to get a better handle on your finances.
I've been using them since 2012 and have made much wiser financial decisions since. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.
After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Input various expense and income variables to see how you stand. Your goal should be to get to a 90% probability of achieving your goal. Try it out yourself for free. Your future is too important not to take it seriously. You don't want to end up old and not have enough money because there is no rewind button!
Tax Savings Recommendation
Start A Business: A business is one of the best ways to shield your income from more taxes. You can either incorporate as an LLC, S-Corp, or simply be a Sole Proprietor (no incorporating necessary, just be a consultant and file a schedule C). Every business person can start a Self-Employed 401k where you can contribute up to $54,000 ($18,000 from you and ~20% of operating profits). All your business-related expenses are tax deductible as well. Simply launch your own website like this one in under 30 minutes to legitimize your business. Here's my step-by-step guide to starting your own website.
Related post: How To Pay Little Or No Taxes For The Rest Of Your Life