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Lesson 4: Tax Refunds Are Not a Good Savings Plan


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A 12-Month Series by Guest Blogger Julia Wessels, from The Frugal Find

April 15th is just around the corner and it’s time to tackle the topic of taxes.  Every year around this time, Americans look forward to a large chunk of change coming their way in the form of a tax return.  Now if this was free money, I could understand why everyone gets so excited.  However this isn't free money at all—it's money you've earned in your hourly wage all year long that you've essentially loaned to the government.  The numbers below should be proof enough.  This isn’t a new concept, but it’s one that many Americans don’t understand or choose not to adapt into their lives.

In 2010, the average Tax Refund was $2,869.  So if you work 40 hours a week for 52 weeks a year you're basically taking a $1.34 per hour pay cut.  You know what that means don’t you?  It means that the average American loaned the government (interest free) close to $3,000 each last year.  

 

Tax Refund

Maybe you didn’t know that you could keep that money in your pocket each month instead.  Would you turn down an extra $240 per month?  Personally, for our family we’ve NEVER received a Tax Refund instead we’ve always had the extra cash in our bank each month—and trust me we needed it and found a way to use it.  All you have to do is claim the correct number of deductions on your W4 form.  Just ask your employer to change it based on the calculations you’ve made here or have figured out with your tax consultant based on your family's situation.

Maybe in your case you’re financially stable and you don’t need that $240 per month (likely not the case for the average American) but if that IS you, have you considered investing that money?

Here are 3 different things you could do with your a $240 per month income:

1.  If you continued to loan the government $2,869 per month for 10 years at the end of 10 years (if you didn’t spend a penny of your tax return) you’d have $28,690.  If you’ve been doing this since you were 30 until you retired at age 65, you’d have $100,415.00.

2.  If you invested the $240 per month for 10 years in a slow growth mutual fund with a 10% return at the end of the 10 years you’d have $50,296.92 – a much prettier number than the interest free loan you’ve been giving the government.  If you’re 30 years old today and you did this until retirement at age 65 you would have $855,325.80 in your account.  You can run the numbers using a Compound Interest Calculator.

Let’s put the numbers side by side here…
Loan the Gov’t - $2,869 X 35 years = $100,415.00
Invest the $$$ - $2,869 X 35 years = $855,325.80

Maybe you’re thinking “I don’t get anywhere near that amount”. Let’s say you get $480 at the end of the year – if you invested that $40 per month ($480 per year) at the end of 35 years you’d have $153,131.07 or $18,200 if you continued to loan it to the government.

3.  If you have ANY amount of debt (and this is a no brainer), that $240 should go to pay down your debt.  Let’s say you’re sitting on $15,000 worth of car loans or credit card debt at an interest rate of 16.86% (average American credit card interest rate).  Just guessing here, but I’d venture to say this person is already paying $300/month towards the debt on the low end.  At this rate they would have their debt payed off in 6 1/2 years and paid $10,000.00 in interest!   INSTEAD, if they put the extra $240 towards debt along with the $300 they’re already paying they’d have their debt payed off in just under 3 years and paid only $4,100 in interest. You can run the numbers using an Amortization Calculator.

Let’s put the numbers side by side here…
Debt of $15,000 @ 16.89% = 80 months (6.5 years) + $10,092.22 in interest paid
Debt of $15,000 @ 16.895 = 35 months (3 years) + $4,100 in interest paid

I know this can be a bit overwhelming, but this simple fact is that it is YOUR money, you’re working every day to earn each and every one of those dollars.  Take charge of your finances and put the ball back into your court!

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