Why A Big Tax Refund Isn't A Bonus
Tax Day 2022 is approaching and millions of people have already filed their tax returns.
(If you’re still finishing up your taxes, don’t worry - the deadline is Monday, April 18th, 2022.)
The average refund? $2,323.
As the average US salary is just north of $51,000, that average refund amounts to nearly 5% of a worker’s take-home pay.
Seems like a pretty good bonus just for turning in your homework, doesn’t it?
Unfortunately, that number doesn’t hold up to much scrutiny. And as we are trying to get better at Adulting (of which paying our taxes is a key part), it’s important to know why getting a big tax refund isn’t something to celebrate.
Fundamentally, it’s because a refund isn’t new money to you. It isn’t actually a bonus, even though it can feel like it when it arrives as a lump sum.
A tax refund is the money you get back from having overpaid your taxes.
It’s money that you gave the government at some point over 2021. The government held onto it. Then they gave it back to you. Essentially, that makes it like a savings account, which is in line with 46% of taxpayers that are going to save their tax refunds.
The problem is a simple one. Think of the $100 extra dollars you paid in January of 2021. Now it’s spring of 2022, almost 16 months later.
If you had started saving that money then, you would have started earning interest. If you’d invested it, you might have gotten dividends. If you had paid down debts, you would’ve cut your interest payments.
And, most pernicious of all is that you’re fighting against an inflation rate of nearly 8%. A dollar doesn’t go as far as it used to. So the dollar you mailed in 16 months ago had more purchasing power than the dollar you’re getting back now.
Now, think about what you could’ve done with the almost $200 more per month that the $2,323 average breaks down to. Could you have saved more? Invested more? Paid down more debt?
When you figure out your answer, we think you’ll agree that it’s worth figuring out how to drop down that refund.
Two Steps To Get The Most Out Of Your Tax Refund
Fortunately, it’s not too late to change.
While we are all in tax preparation mode, keep in mind that while some of these changes do affect tax filings, some are also connected with how your employer pays you.
Adjust Your Withholdings - Here the goal is to make sure you’re paying the right amount of tax. This is the money that your employer withholds from your paycheck to pay the Federal Income Tax. Using the IRS Tax Withholding Estimator, you can ensure that the right amount is being withheld from your paycheck. If too little is being withheld, you’ll end up with a bill. If too much is being withheld, you end up with a refund.
- Reduce Taxable Income - This may end up increasing your tax refund because the focus is on only paying taxes that you should be paying, or not overpaying. For more information on tax deductions, tax credits, expenses, and donations, Investopedia has a comprehensive article.
As a reminder, these are general suggestions and not intended to be taken as financial advice, so be sure to do your own research, too.
With all that, we wish you a smooth tax prep. Isn’t adulting fun?