The average tax refund is around $1,850 in America according to the IRS for 2018. That’s down 8.5% from the year prior due to Trump’s Tax Cuts And Jobs Act which raised taxes on Middle Class Americans.
Since saving, or not spending $154 a month is difficult for many, I’m OK with such a refund.
With basic savings interest rates around 2.4%, your opportunity cost is not huge.
If we are to compare the average tax refund to the average per capita income in America of $61,000 (~$40,000 after tax), $1,850, or roughly 3% of income is a pretty meaningful number.
Your goal should be to not only max out all your retirement plans (401K/IRA), but to also then save another 20%+ if you’ve been a long time reader of this site. With 7% out of 20% down, you’ve only got to find a way to save 13% more! Not bad at all.
There’s a big debate on whether you should have a tax refund at all, given that simply means you overpaid our incredibly inefficient and wasteful government.
Since most people can’t save for cookies, I’m of the opinion that a tax refund is good for most people.
A QUICK MENTAL EXERCISE ON YOUR TAX REFUND
Let’s do a little exercise, shall we? Since we all make various amounts of income, take your average annual gross income over the past 3 years and multiply it by 6.5%.
Are you happy, or disgusted that you will be getting a refund of that size? I’d personally be very disgusted if I knew the government was keeping that money from me all year long to go give themselves raises and spend money on frivolous things which further increase our budget deficit.
What’s important to realize is that numbers mean very little in a vacuum. You always need to be comparing one number to another, to get some sort of perspective.
If you love tax refunds and make $1 million a year, $3,000 isn’t going to elevate your heartbeat one tick. However, if you got a $65,000 refund, you’d probably be ecstatic.
Mathematically, I’ll tell you that it is virtually impossible to get such a size-able refund if you make that much thanks to all the phase-outs.
In fact, if you are making over $500,000 with a W2 (not a small business), you will likely be paying out the wazoo come tax time!
WHAT TO DO WITH YOUR TAX REFUND
With the perspective that $3,000 is potentially 7% of your total annual after-tax income in mind, there’s really only several things I recommend you do with your refund.
* Make it disappear. In other words, put your $3,000 into a savings account at another bank so that you cannot access it easily. Don’t go blowing your $3,000 on anything unnecessary, unless you’ve already maxed out your 401K and saved more than 20% of your income. Trust me when I tell you that your savings will grow immensely over time if you are disciplined. You’ll wake up 10 years from now and see $40,000 in the bank, just from tax refunds!
* Pay off your credit card or car loan debt. Listen, if you have revolving credit card debt that costs much more than 5%, you really have a spending problem. You do not deserve the things that you are buying because you simply don’t earn enough. It is stupid not to pay off your credit card at the end of each month and take advantage of a free 30 day grace period.
Furthermore, if you have a car payment that has an interest rate of much more than 5%, and whose value is more than 10% of your gross annual income, you are also wasting your money. Seriously, these two debts alone are hurting your freedom now, and in the future. Get rid of them and follow the 1/10th rule of car buying for goodness sake!
* Help someone else. If you’ve already put on your oxygen max, use the money to help someone else put on their own. There’s nothing better than helping a friend or loved one in need. Theoretically, we can “over save” to the point where we are severely crimping our lifestyles and generating a bunch of angst in the process. Carefully tweak your savings rates each month to see what your comfortable zone is. I believe one should spend their money as they see fit, but not at the expense of their future retirement.
* Invest in yourself. This is my most favorite option because the returns on investing in your education, communication skills, language skills and so forth are multi-baggers! It always seems a little foolish to pay $1,000 for a presentation class until you confidently get on stage and wow your listeners to act. Learning another language is priceless if you are dealing with that particular region for business. I firmly don’t believe one can get enough education.
* Invest in your business. If you’ve got a small business, don’t be afraid to spend some CAPEX to provide a better experience for your customers. Obviously weigh the amount of money you will spend by your current revenue, balance sheet, margins, and payback period. I view a small business like one’s child. Nourish it and watch it grow.
DON’T BLOW YOUR TAX REFUND!
A tax refund feels good. Even though a tax refund is rightfully your money in the first place, it feels like we are getting an extra bonus for the year. And what do we tend to do with special bonuses? We tend to reward ourselves. Savings and the comfort a cash pile brings alone should be your reward. Don’t blow your refund on stupid things, unless of course you are stupid and can’t help yourself.
Oh what the heck, let’s go to Vegas and put it all on black baby! And if it doesn’t work out, there’s always next year, right? Do the right thing and save your tax refund or pay down debt you know you shouldn’t have!
Tax Savings Recommendation
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Updated for 2019 and beyond.
I owe the IRS about $60K (30K in 2016 and another 30K last year) and are trying to get into a payment plan. I consulted tax relief guys but they assure me I would not qualify due to my income. Together with my wife we make about $160K a year and are claiming 0 dependents. Just bought a house and will be paying about $35K in interest for the next few years. I’m also planning on installing solar which will give me a $30K tax credit next year.
If I cant get out of this in the next two years (refunds, credits….whatever else I can do…) I think I’m going to try Chapter 7. Any suggestions, please?
Disagree on auto debt. If you owe what its worth, just keep paying your payment. Only reason you would want to pay it down is:
1) Keep your car until the wheels fall off. (hardly anyone does)
2) outrageous interest rates… (in that case should be looking to refinance options)
3) looking to sell but owe more than its worth
Why invest your cash into the worst investment one can have (depreciation).
A far better debt to put it towards is credit card debt or Student Loans! Student loans is a lifetime investment high interest rates!
How do I subscribe to your financial site? I am 38, average approx under $13,000 annually (made loads more in past/poor legal & life decisions now impede my employability) am too motivated to settle there due to past. I just desire to only live moderately now w/peace of mind for my future.
I own no home; car; credit card; or land! Where & how do I start my $ future?
This year’s tax refund = paying off our car loan early.
Just read this article, great advice. I received 5k back in a refund, normally I wouldnt allow the gov’t to keep all that money, but it was my first year itemizing as I bought a house last May. I’m working on keeping more of that money this year. I used it to pay down some low interest debt, and save for some life goals I have. I may invest a portion into Lending Club, as Ive been waiting for some extra cash to put in there, I have been enjoying good returns.
Sounds good Justin. Did you keep your promise and pay down debt and invest in Lending Club?
I did pay down debt! Though I stopped funding my lending club account because Michigan won’t allow you to invest in microloans directly (at least not online), so I have to purchase notes through the secondary platform…it was cool at first, but the more I put in the harder it was to seek out and purchase the notes individually and then to continually reinvest as they were paid off. Returns are great, but considering the time value of money, it was taking up way too much of my time for too little money.
I wish I was average and living in the US :) I am only getting about $1000 back on my tax refund. I plan to put it in a registered account (get rid of it) like a TFSA or the RRSP. I would say I’m pretty disciplined with not wanting to spend that money on a trip or a big night out to vegas ;)
Ahh, but if Vegas was only a 1 hour flight away, maybe you would! Is there legalized gambling in Canada anywhere?
LOL YES there is legalized gambling in Canada! We need to hold a Yakezie meet up here in Canada just to prove it to you ;)
Mind you, you don’t get the free cigarettes and booze that you would in Vegas!
Caesers has a location in Windsor! Just across the Detroit River
Making wise decisions now will determne who will be free later.. I made the mistake of getting into credit card debt and now I am sacrificing to get out of debt. Half of my tax refund will go toward paying off my credit card debt and I will not even blink. Money is nice but Freedom is my main goal.. Make wise decisions people it will benefit you in the future!
Indeed, however was your CC spend a mistake? I presume you had fun spending that money and got something good in return yeah?
Great advice, I’ll be shoveling most of it into investments.
I like the “Invest in yourself and your business” sounds like sound advice.
Of course, there are always internet cafes (lol) ;)
I’ll invest it; I need to make up for the lost interest! :)
This will probably be the first year I don’t get a big refund. I made a lot blogging this year! I’ll take it.
In years past, I always put a bit into IRA, a bit toward vacation and then blew the rest throughout the year.
How can you contribute to an IRA when the limit is like $100,000 income or lower?
We will be putting the majority of ours into investments and savings. A small portion will be used for our trip to Asia.
That must be a large refund if only a small portion is being used for a trip to Asia! Flights alone for 2 from the US is probably going to be in the $3,000 range.
I go to Asia every year for 6 weeks on vacation and generally spend about $7,000 for this trip.
It is a decent size. We are lucky where we live in Canada because we get 60% of our education costs back on our income taxes if we stay here working. We actually found some really great deals on flights to Asia so this helped. We have also been saving ahead of time so we can pay cash for our trip. Any extra money we get like our tax refund can go into future savings.
When we are on our trips to Asia, we always joke about being from Canada! We see so few other Americans on our trips.
People are always amazed when I say I’m from America, especially when we were in Malaysia in November of 2001.
Have a great trip. Not sure if going to Asia this year. Maybe South America or India instead.
Tax refunds are always a nice surprise although mine seem to keep shrinking. I try to budget for the year as if I’d get 0 refund or even owe taxes. I claim 0 deductions during the year too so that I can limit my urge to spend money I may end up owing too.
We usually owe but last year I miscalculated our withholdings and we are getting a refund. I absolutely agree with everything you said (hey, people do need to learn another language even if they don’t do business in that particular region) but… I am going to Vegas. Yep… a very trivial thing but I am doing it. :-) and I am damn excited!
Have fun in Vegas! Put a $100 black chip for me!
We haven’t done our taxes yet. We added a dependent this year, so I know we will get a refund, just not sure how much. We will probably use a large chunk of it to pay for my daughter’s preschool where she will learn Japanese (my husband’s native language). If we don’t use it for that, we will save it for our next car fund.
I really like this post. Too many people just squander their tax refund without thinking about it.
How about having your daughter learn Chinese instead? I’m all for Japanese, but the real growth of the future is in China!
I thought you were going to say buy some gold coin and stuff it in your mattress on the hide your money option. :)
I don’t think we’ll have any refund either. Usually we owe the IRS a bunch of money every year, but I just stuck 4k into the 529 so maybe that will help out this year.
Good luck! Let me know how it goes! Generally owing money is a good thing though!
No big refund for me! Frankly, I don’t believe in big refunds. I have not done my taxes yet, however, I expect between Fed & State, it will be less than $500. I try to adjust my withholding to keep the refund low, because I would rather put the money to work for me during the year.
I have difficulty putting money to work throughout the year, so I’m happy to have a more meaningful chunk at year end to invest or do whatever. Even if I had $1000+/month in cash-flow, I see it as something not meaningful enough as the temptation is too great to spend, and the amount too lowto get any returns. $12,000 however gets more meaningful.
It is a matter of perspective, I like the idea of dollar cost averaging into the market.
Do you put extra money into the markets instead of savings? It seems common place, put, but it’s not for me. After company stock, 401k, and such.. putting more disposable income into the markets doesn’t sit well with me.
I am heading to my accountant in about 10 mins! IF I have a refund my plan is to follow your advice. Exactly.
Most will go to my auto debt and then some into a liquid savings account that I don’t really look as my money.
Let us know how it goes! Get rid of that ridiculous auto debt, unless it is a sweet ride like a Lambo!
Working on it! I have killed like 7K of it since last April.
Nice! How much more??? Do it man, kill the beast!
We have to pay every single year. We both claim 0, but it doesn’t matter. So, I don’t ever have to wonder what to do with my refund. Instead I have to come up with money to pay…
Every year? Hmmm, what about itemized deductions like mortgage interest and stuff? Perhaps you should incorporate a business.
We itemize whatever we can, but it doesn’t matter. Part of the problem is I max out my 401k. Since I just work part time, my after tax income can be pretty low (less than 1k every 2 weeks.) I think some computer program decides I make so little money that it barely takes out anything for federal taxes. I probably should do quarterly payments I guess.
Instead of doing quarterly payments you can just have extra $taken out every paycheck.
If that’s the case, you should be thrilled that you are paying so little taxes throughout the year!
My tax refund is paying the IRS somewhere north of 750 (numbers havent been finalized yet) but I like your suggestions. I think that saving it or putting it to my debt is what I’d do if I actually got a refund.
Any mortgage interest to deduct? That’s what saves me every year.
nope, dont own a house. best I got this year was student loan interest deduction, it saved me about 500
Gotcha. Thanks not a bad savings! I’m not sure what else can help alleviate your tax burden except for a house and starting a small business.
For me any “windfall” whether it be a tax refund or unexpected money is split into two categories. A major chunk, 90% or so, is put towards savings and I just leave it. Then I take about 10% and use it to enjoy myself. This could be a wild night out, a weekend getaway, or buying something that I had my eye on.
That’s a pretty good ratio. Good to live it up a little.. and 10% is not much. Definitely go and have the time of your life in the 20s!
Well, we’re not going to Vegas with it. Most years, our tax refund is allocated to either savings or purchase of an asset.
Booo….. boring! Just kidding. How about that Italy trip you went to?
Ah, but that was a business trip. I know, the thought that pops into most people’s heads when they hear that is, Gee, life must be tough.
I like that you put help someone down as an option.
I personally love hiding money from myself.
Our next goal is to save for a house that has an inlaw suite so that my mom can move in with us. It will probably take at least 2 years to get the money we need to upgrade to a bigger place.
Sounds like a good goal to have! Saving money with no goals feels somewhat empty. However, hopefully we all have the long term goal of saving for retirement.