What Should I do with my Tax Refund
As we all gather our W-2’s, 1099’s for the self- employed, 1098-E Student Loan interest statements, 1098 Mortgage Interest, and every other tax document that you try and remember for your accountant this year, we begin to think about the potential refund and all of the glorious things we can spend or save for this year. After seeing a recent graphic from GoBankingRates.com I couldn’t help myself than to share what the average Joe American will be doing with their tax refund. Get your tax estimators ready boys and girls it’s tax refund time.
27% Pay off Debt
According to CNN Money the average refund for 2015 was $2,893, which is an estimated provided by the IRS during the course of 2014 tax returns. I plan to use this number throughout and call it an even $3,000 to make things simple and have a nice round number. It’s with great excitement that I see that the highest percentage of Americans who receive a tax refund will be paying down credit cards, student loans, and all of the other debt instruments that cause the average Joe scrapes and bruises of interest payments this past year.
For the first time ever in my life I will not be part of this category. I paid off all of my personal debt in 2015 and this one is checked off the list. I cannot say enough good things about using this extra money to make your debt repayment change from a house cat to a lion, chasing down the prey known as debt.
Let’s think outside of the cubicle for a minute and a common theme throughout this article and ask “what can your tax refund do for you”? Adding an extra $3,000 one-time payment to a $200,000 mortgage at 3.75% can reduce the loan term by 9 months and save you over $6,069.83. It’s another way of saying I want to double my money, food for thought home owners.
Here’s another one to think about. You are given 2 options: 1) Receive $250 for the next 12 months or 2) Receive $3,000 at the end of 12 months. Which one do you choose? Even Steven Money wants the money upfront because he knows that he’s a smart guy and do great things along the way, like make extra payments every month to reduce the amount of interest he pays to big brother bank that has his loan. Escape the cubicle faster and miss out on Richard’s 40th birthday party filled with cake and awkward stares? The answer is YES, I can eat cake any time I want if I’m punching numbers into a computer for 8 hours.
25% Put in Savings
Oh you fantastic money saving American people, I had no idea I loved you like my own son with this glorious 25% category. I am proud to say that 1 out of every 4 Americans are saving their tax return money. Don’t let the .01% Interest rate of big banks scare you away, sure it feels like you are just stuffing money under your mattress, but the reality is things like life happens, cars break down, little Jimmy breaks his ankle, Momma D needs some new dentures, I don’t know what is going to happen next, but I do know that having a little savings on the side is a nice thing to have instead of the “broke monster”*.
This year is the first year I am able to put my tax refund into savings. While 2015 was dedicated to paying back student loans and my parent’s loan, I dipped into Mrs. ESM savings (we keep our savings separate) and will be beefing up her/our rather paltry savings account with this year’s refund. Although I am a tricky, tricky personal finance blogger and may have convinced the afore mentioned Mrs. ESM that she will be the proud owner of some Roth IRA index funds from Vanguard, I know she’s as excited as getting that $2 from Grandma that every child couldn’t wait for each year as your birthday present, even at 28 years old, NEVER gets old Grandma, thanks again, sorry THANKS AGAIN GRANDMA.
So we need some get out of the cubicle thought right here. As I mentioned above we are receiving $3,000 and even if we received the best interest rate in the market according to Magnify Money** for a 12 month E-Savings account we would be earning 1.10% and $33. I’m not saying if I at my bank’s ATM and a screen popped up that said Congratulations we like you more than any other customer and will be depositing $33 today, I wouldn’t leave with a smile on my face and repeat visits to see if it happened again, but let’s think bigger. Do you think $3,000 could start a business and make more than $33? I think Chris Guillebeau would respond with a loud YES! His book in fact is titled The $100 startup: Reinvent the Way You Make a Living, Do What You Love, and Create a New Future. I think it’s a great way to make more than $33, it’s betting on yourself and I like your odds my friend, especially if you are reading personal finance blogs for fun.
One more that I can relate to is taking your tax refund and starting a blog. By far this has been the best use of my money over the last 2 years. Writing on the blog has increased my accountability, gave me the chance to share my thoughts and fears about money to people that will listen and rarely judge, and given me the opportunity to meet new people that I think are the smartest people about money in America. If you want to start a blog, give Bluehost a try, it’s what I use today and I don’t hate them, so that’s not so bad. They will also pay me if you use that link, well I think they will, don’t worry I’ll keep my fingers crossed.
9% Put towards a vacation
I 60% recommend 100% of the time, putting money towards a vacation. And why yes that is a cheap rip-off of an Anchorman quote used to make spending money on vacation funny. I personally think that using savings for a vacation is a very smart thing to do, even if you are in debt. I don’t mean fancy vacations to Europe sitting in first class eating out at Michelin restaurants, but I do think visiting family who lives in Florida so the kids can swim around in the pool is not going to kill your debt repayment plan.
Here is the wording of the survey that makes me get a little worried with the 9% who chose this category of, “Put towards a vacation”. The wording makes me believe that while the average American is getting their $3,000 tax refund, they are putting this towards a vacation, not for a vacation. What’s the difference? They are taking the $3,000 and buying plane tickets to see Mickey Mouse down in Florida for the family, but then putting the housing, food, and souvenirs on the credit card. See the difference now?
What this behavior leads to is credit card debt and moving your fancy vacation into the “stupid” part of the 9% because this will just land you in the 27% that are paying back debt in next year’s Go Banking Rates survey because of your “spend a ton of money on vacation plan”. You know YOLO, I deserve it, and some other sayings that I’m proud to say I don’t think I know of.
I certainly don’t know if I’m a frugal weirdo, but I certainly have my frugal tendencies. Yes, I break down the cost of riding the train to get to O’Hare with friends vs the Uber breakdown and yes I will be asking them if they have signed up for Uber so we both can get a free ride to the airport, feel free to sign up as well. I may also while on my daily walk with my dog check down every alley to see what the potential is of the garbage that was recently discarded, but frugal weirdo……..well maybe.
5% Make a major purchase
Now here I’m going to make an assumption that the tax refund of $3,000 is being added to a much larger sum of money that you have been saving for this major purchase. I know that the average American wouldn’t just get the monies and impulse buy a new Toyota Camry because the tax refund deal they are having this year is A-M-A-Z-ING, right? Also I’m sure we wouldn’t get a tax refund and then go out and buy a home using this as the down payment? Because you would have a larger down payment to go along with it and some emergency house funds to make sure the air conditioner doesn’t give out or one of the water pipes breaks in the house. No, we are prepared for that, this is just in addition to our big amount of savings we already have.
Remember we are looking at this tax refund as a way to jump away from the grey cubicle walls that are starting you in the face from 9-5 every day. Let’s do something that will get us there faster. Let’s use a family member as an example, let’s call him Michael. Michael almost fresh out of college began his first real job; they gave him a salary and everything. Now Michael couldn’t have been more excited, he has big plans of paying off all of that student loan debt that he carries along with him. Way to go Michael, we are so proud of you. Then it happens the vehicle that he has had since high school isn’t as dependable as it used to be. A trip back to see Mom and I he realizes the car just might not make it home, most of us have all probably been there. Our car isn’t acting right, not dependable, etc. and now you have money, a job, and even a credit score.
All those days of refilling the oil at every gas station are over. You probably know the rest of the story because you yourself may have been Michael, I know I was. This is what happens next “big plans of paying off all of that student loan debt” So you head to the local dealership where a friend referred you and just a little while later you are driving away in a brand new Jeep Grand Cherokee, which costs you $34,000 and $500/month, but wait you used that $3,000 tax refund to not pay $37,000. This is the point where I go to slap on you the back and tell you how great your car looks, but instead since I’m Even Steven Money, I hit you upside the head and tell you to bike to work. For the love of God, you live less than 2 miles away.
I wish that I would go on Facebook after tax season and see someone named Michael or otherwise and show me a picture of a $3,000 1998 Honda Civic that they bought for cash after selling their brand new Jeep Grand Cherokee.
4% Splurge on a Purchase
This is the category that worries me the most. Every day we are challenged by advertisements on our google searches, subscription emails about a shopping sale, mobile ads to entice us to buy more, and television commercials to get the latest and greatest “thing”. When I say we are challenged, I really mean it. Today, we can expect to see over 5,000 advertisement and brand exposures per day according to this NY Times article. There is a really good chance you have been battling all year not to spend money on your credit card for that new TV you wanted, Air Jordan’s that sold out in stores, or new dress in the window you walk by every day after your train ride to the city. Over 5,000 times you said I can wait, but now that you have an extra $3,000 in your hands from the government***, that money will be going towards a new “thing”.
We are here today to take out the drill and unscrew the wall in front of you a la Office Space. Let’s eliminate the 4% out of all of us, which I worry is a much higher number than presented here. Is that new TV a need over paying off a credit card balance? Do you think you deserve a pair of Gucci loafers more than your student loan needs an extra payment? What are you doing to make this number 0%?
Do you think I’m crazy to think this number should be 0%? If you are itching to spend a new crisp dollar bill that comes into your hand, then the cubicle nation will be in your future for a long time. If “stuff” is your splurge then I suggest getting ready for the long haul of working extra hours for the next 30 years. If you love the “VIP” line at the Coach store, which I can’t even possibly put into words how much this angers me, then I suggest you plan on earning globs of money and making a few sacrifices along the way and just make sure to remind yourself when you are working on a Saturday or putting in 55 hours that it’s going towards a Coach purse. Just make sure you value your purchase today as much as you will in 25 years.
30% I do not receive a tax refund
This category was saved for last as I plan to end on a high note. No, I didn’t purchase a medical marijuana dispensary as my new business idea, but I certainly have good intentions with average American surveyed here.
When doing your taxes each year you essentially have 2 options:
Option 1: Pay in more money to the government and wait till tax season for a refund of this money
Option 2: Pay in less money to the government and when tax season comes around you will not receive a refund
In an ideal tax plan you would pay in the exact amount of money to the government so the total expected would be $0. It certainly is difficult to get this to the dollar, but to get it plus or minus $100 I think is a real possibility, just by using a tax estimator found with a simple google search and inputting your tax data from the previous year. Did I lose you? Hope not because here I come with the Good Stuff!
The best mathematical approach to taxes is not receiving a tax refund or owe the government money.
This solution gives you the highest possible return on your money. Why’s that? Think about it like a race with your cubicle mate sitting across from you, now if they are the 25 year old recent college graduate who eats salad for lunch, they will run circles around you head to head. But what if they wore a backpack full of bricks for the first 30 yards of the 40 yard race and then for the last 10 yards they took off the backpack and sprinted the last 10 yards without the backpack? You could win then right? If the answer is not yes please start eating salad and going for walks during lunch instead of hitting up the vending machine and checking if anyone has leftover Valentine’s Day candy.
You see the comparison right? If someone gives you money upfront you have a longer time period to invest and save than your 25 year old recent college graduate. In essence you get to start the race with a head start, no bricks in your backpack. Of course if sweet Gladys who brings you freshly baked cookies every Monday is sitting across the cubicle divide, then you get to run the race with bricks weighing you down and if I’m a betting man, sweet little old Gladys will hop right over you as you collapse to the ground in exhaustion.
Just to give you an idea on what kind of difference this makes, if we take $250 invested at 8% for 30 years our total value will have increased to $375,074 versus adding $3,000 at the end of every year would net you $367,037 or a difference of $8,000, assuming I put the numbers in the calculator correctly. Of course as that $250 monthly turns into $350 and larger, the bigger the difference in our total value of money will become.
As I wrap up this long, long breakdown and shake your hand for hanging on this long. I want to share one last little cubicle moment for those of us reading today that struggle with saving, paying off credit card debt, or saving for that big vacation with the family. Just because it’s the best move mathematically to receive your tax refund upfront little by little over the year, it’s also in our human nature to spend and make a “human error” along the way. So don’t feel bad or discouraged about the numbers rather feel great about paying down that loan or saving $3,000 throughout the year.
Whatever category you find yourself in come April 15th, make sure you are doing what’s best for you in the long term. I promise that if you take the time to think about what you plan to do with your money, then you are doing better than the average Joe American. Let’s take a little time out of day to plan the smartest way to use our money and be an Ameri-CAN Saver, not an Ameri-CAN’T.
*The broke monster is not fictional, he does live under your bed and you should be scared of him, your brother Kevin is not making this up, he was attacked last week and his credit card statement can prove it.
**I’m not an affiliate with Magnify Money, but I “Know a Guy” who is, so if you plan to open a savings account any time soon, use this link instead, I’m sure they would appreciate it. I listen to the podcast and I even do it by choice.
***Let’s be clear this is not extra money and this is not from the government, it’s simply the money you earned and let the government hold on to for the last 12 months.