Updated for 2021
Most of us celebrate getting a huge tax refund – we have big plans for that money every year. We act like getting that big chunk of change is a good thing, but it’s not. In fact, you actually lose money by giving the Federal government an interest-free loan every year.
According to the IRS, the average tax refund for tax year 2019 was $2,549, which works out to $212 a month. But if you put that money to work for you instead of lending it to them, you could end up with a much bigger pile of dough.
Here are 3 very lucrative ways you could be using your tax refund all year long instead:
- Turn $2,549 into $258,633 by funding a Roth IRA
When it comes to retirement savings, a lot of us are way behind. The simplest way to build a solid retirement nest egg is to open a Roth IRA account. Now, you won’t get a current tax break with a Roth IRA, but you will have access to your money without tax penalties, and all of the earnings are tax-free. If you put that $212 into a Roth IRA account every month for 30 years (and didn’t take money out early), and earned an average 7% annual return, you’d end up with $258,633. That’s right – you’d deposit a total of $76,320, and the rest would be pure, tax-free earnings. That's a lot more than a single $2,500 tax refund!
- Save thousands of dollars by paying off credit card debt faster
Credit card debt can be overwhelming – and so many of us get stuck in the credit card trap. Those balances build up frighteningly fast, and before you know it you’re paying interest on top of interest. The credit card companies are happy to let you make just the minimum monthly payment, but it’s impossible to get out of debt that way. But take that extra $212 and add it to your credit card payment – that’s like getting a 16-21% return on your investment (and that pretty much never happens). Let’s look at an example of how using that $212 over-withholding could save you big bucks in credit card interest – and get you out of debt much faster.On a $5,000 credit card balance at 16.99% interest:
Paying just a minimum monthly payment of $200: It will take 130 months – nearly 11 years – to pay off the balance, and you’ll pay $2,625 in interest.
Adding $212 per month to the minimum payment: Your credit card debt will be paid off in 1 year, and you’ll pay only $526 in interest… a savings of $2,099.
According to NerdWallet, the average credit card for households that have credit card debt tops $7,000.
- Build up your emergency fund, earn interest, and reduce credit card dependence
It’s alarming: According to a survey by BankRate.com, 61% of Americans have less than $1,000 in savings … not surprising after insanity of 2020. But that means most of us don’t have enough to cover even one month’s worth of expenses, a very precarious financial position. If you have a job, you can update your withholding taxes to get less money taken out of your paycheck. That way you get to keep more of your money during the year, you can build up a substantial emergency fund in no time at all.If you funnel that $212 a month into an easily accessible high-yield online savings account – the best interest rates on savings right now are about .60% – your emergency fund would top $2,500 in just one year, and grow to more than $5,100 after two years. And while earning $30 in interest in two years isn’t exciting, consider that you’d be paying close to twenty times that much in interest if you had to use credit cards for emergencies.
All it takes to achieve these financial milestones is making that first change – adjusting your withholding so you can put your money to work all year long, instead of giving the government another interest-free loan.
Not sure how to update your withholding? Want to know how much you can safely increase your take-home pay without owing taxes? Contact me with your questions, and we'll figure it out together.