Why Getting A Big Tax Refund Is A Red Flag For Your Wallet
The majority of taxpayers receive a refund. In tax year 2022, this amount averaged a substantial $2,800, according to Northwestern Mutual. At first, it sounds like a great thing to learn that a significant tax refund will be on the way.
The truth is that getting a big tax refund is a red flag for your wallet. A straightforward reason for this is that receiving a tax refund means that an individual has actually loaned their money to the United States government. One major downside to this action is that the government is not paying any interest for this de facto loan.
Waiting all year for this tax refund is not an ideal financial plan. Many Americans are carrying either high interest credit card debt or significant student loans. Rather than lending this money to the federal government, they could be saving money on high interest costs or saving for retirement instead, Northwestern Mutual points out. Instead of wondering how long it will take to get a tax refund in 2025, the money could already be put to work.
Debt paid down earlier will save on high interest rate costs
The average $2,800 refund amounts to $233 per month over the course of a year. Individuals could use this monthly money to pay down debt or at least to avoid going into debt during the year. A large number of Americans are carrying high interest credit card balances, according to Northwestern Mutual.
These interest rates are often 18% or even higher. By using the extra money per month to reduce credit card balances, individuals can save a substantial sum of money going towards interest payments. Even for those who have interest rates that are not so high, it is better not to carry significant card balances.
The idea that having this money in hand now is better than loaning it to Uncle Sam for a year only works if individuals use the money wisely. This extra monthly cash should not be utilized for an enhanced lifestyle or to purchase the next trendy technology gadget. Those who can not be disciplined enough to put the money to work might be better off sticking with the forced savings of waiting on a refund, according to Northwestern Mutual. In these cases, there is a way to track your tax refund until it arrives.
Money loaned to the government could be saved for retirement
This money that American taxpayers are loaning interest-free to the government could also be contributing towards retirement. If individuals allow the government to use the $2,800 average refund amount for a year, then they are losing the chance to add to savings and investments. Rather than wait on a refund for overpaying throughout the year, individuals can increase their contributions to 401(k)s by one to two percentage points.
This may not sound like so much, but over a few decades it makes a real difference. The change in contributions could allow for a more comfortable retirement down the road. Waiting to put this money to work for a whole year is the same thing as forfeiting appreciation on it for the year. Besides this, there is a tax credit that might be missed.
For individuals who make this change, it is essential to come up with a plan. The important part is to stick to this plan. According to Northwestern Mutual, a good choice is to set a recurring automatic transfer on paydays that moves the money from checking to investment or retirement accounts or to the student loan company. Alternatively, individuals can set up increased 401(k) contributions to match the extra money received each month.