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Tax Refunds Are Good For Most People Because Most People Can’t Save

Updated: 02/18/2021 by Financial Samurai 57 Comments

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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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.

Start a simple business to pay less taxes and contribute more to pre-tax retirement accounts
Start a simple business to pay less taxes and contribute more to pre-tax retirement accounts. Instead of paying taxes on $100,000 in income, you’re only paying taxes on $12,000 for maybe a $2,000 tax bill, or 2% effective tax rate.

Related post: How To Pay Little Or No Taxes For The Rest Of Your Life

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Filed Under: Taxes Tagged With: concepts, hmmm, Reality, weakness

Author Bio: I started Financial Samurai in 2009 to help people achieve financial freedom sooner. Financial Samurai is now one of the largest independently run personal finance sites with about one million visitors a month.

I spent 13 years working at Goldman Sachs and Credit Suisse. In 1999, I earned my BA from William & Mary and in 2006, I received my MBA from UC Berkeley.

In 2012, I left banking after negotiating a severance package worth over five years of living expenses. Today, I enjoy being a stay-at-home dad to two young children, playing tennis, and writing.

Order a hardcopy of my new WSJ bestselling book, Buy This, Not That: How To Spend Your Way To Wealth And Freedom. Not only will you build more wealth by reading my book, you’ll also make better choices when faced with some of life’s biggest decisions.

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Comments

  1. Taxes says

    July 29, 2012 at 9:47 pm

    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.

    Reply
  2. Financial Samurai says

    April 17, 2012 at 7:27 am

    Getting 11K back is sweeeet! I’d be pumped! Good for you for paying down your loans.

    Reply
  3. Wild Bird Food says

    October 11, 2011 at 6:02 am

    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.

    Reply
  4. Isabella@Pet Food says

    September 5, 2011 at 9:30 pm

    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..

    Reply
  5. Alan says

    August 12, 2011 at 10:32 am

    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.

    Reply
  6. Andrey says

    July 22, 2011 at 2:40 am

    The source of the problem is that we are numb to the withholding out of our paychecks. It should be resolved at first.

    Reply
  7. physical therapist says

    June 27, 2010 at 11:53 pm

    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

    Reply
  8. Single Mom Rich Mom says

    April 10, 2010 at 4:45 am

    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? =-.

    Reply
  9. RainyDaySaver says

    April 2, 2010 at 3:05 pm

    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 =-.

    Reply
    • admin says

      April 2, 2010 at 4:59 pm

      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!

      Reply
  10. jay says

    March 1, 2010 at 11:01 am

    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.

    Reply
    • admin says

      April 2, 2010 at 1:07 pm

      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! =-.

      Reply
  11. Dollars Not Debt says

    February 4, 2010 at 6:56 pm

    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 =-.

    Reply
  12. Roger says

    January 31, 2010 at 6:50 pm

    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 =-.

    Reply
  13. Daniel says

    January 29, 2010 at 10:36 am

    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 =-.

    Reply
    • admin says

      April 2, 2010 at 1:05 pm

      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! =-.

      Reply
  14. BG says

    January 27, 2010 at 11:49 am

    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.

    Reply
  15. Chris says

    January 25, 2010 at 5:29 pm

    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 =-.

    Reply
  16. Marc says

    January 25, 2010 at 10:22 am

    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?).

    Reply
    • admin says

      April 2, 2010 at 1:03 pm

      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 =-.

      Reply
  17. Kosmo @ The Casual Observer says

    January 24, 2010 at 2:10 pm

    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 =-.

    Reply
  18. admin says

    January 24, 2010 at 1:36 pm

    @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.

    Reply
  19. Kosmo @ The Casual Observer says

    January 24, 2010 at 12:40 pm

    @ 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 =-.

    Reply
  20. admin says

    January 24, 2010 at 9:28 am

    @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 =-.

    Reply
  21. Len Penzo says

    January 24, 2010 at 8:52 am

    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 =-.

    Reply
  22. Kosmo @ The Casual Observer says

    January 24, 2010 at 5:35 am

    @ 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 =-.

    Reply
  23. Monevator says

    January 24, 2010 at 2:07 am

    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.

    Reply
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