If you are feeling proud of the tax refund you snared after a weekend of working on taxes, I have some bad news for you. You might have blown it. Although people love getting refunds, a refund typically means you wasted your money.
If you are feeling proud of the tax refund you snared after a weekend of working on taxes, I have some bad news for you.
You might have blown it. Although people love getting refunds, a refund typically means you wasted your money.
When you get a refund, it means you paid too much in taxes throughout the previous year. So at the end of the year, the government has to send some of it back to you after you file your tax return. That, of course, means that the government has had the benefit throughout the year of spending and investing your money. And you didn’t get the full value of the money you worked so hard to earn.
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Consider this: Let’s say you just found out that you are entitled to a $3,000 tax refund. That means you overpaid your taxes by $250 a month during the year. And you made the government happy, because Uncle Sam invested that money and earned interest while you got by each month with less of your own money.
Now think, instead, about how you could have used $250 a month to get rid of your credit card debt in 2009. If you don’t pay off your cards completely each month, you are being cruel to yourself — maybe making yourself pay 25 cents a year for every $1 you spent. But you could have been more kind to yourself. If you had received $250 a month instead of letting the government have it, you could have paid $250 more than the minimum payment on your credit cards. That’s the way to remove the noose from your neck fast.
Or, let’s assume that you put $250 a month from your paychecks into a savings account. And around mid-year you invested the $1,500 you accumulated into a CD paying 3.5 percent. Instead of getting the $3,000 refund from the government after filing your taxes, you will have a total of about $3,050 because of the interest you earned.
That’s not a huge amount of money, of course, but it’s better than wasting it. Or to think of it another way, if you saw me on the street today, and I handed you a $50 bill, would you be happy or uninterested?
Of course, this gets even better the longer you keep your money invested. Let’s go back to the original $1,500 and assume it stays in a CD for five years. That will give you about $1,780. It would be even more if you invested $250 every month, but I’m assuming you spent about half of your money.
Incidentally, if you invest $1,500 this year and another $1,500 for the next 20 year, you will have close to $50,000 in your CDs — maybe a lot more as interest rates go up. So think about that when you do receive your refund. Invest it now, and add more money to it each month.
Now, it’s important to act so you don’t let Uncle Sam have this money instead of you during 2010.
1. Contact your payroll office at work today and tell them you want to change your W-4. That’s the form that tells the government how much of your pay to withhold from your paychecks. Add exemptions to the form so you keep more money. But don’t overdo it. Although you don’t want a refund when you do your taxes; you also don’t want to find out next February that you need to send Uncle Sam a check for the 2010 tax year. This calculator will help.
2. Make a plan to invest the money you save. You can put it in the bank in a CD, and find the best interest rates at www.bankrate.com by clicking on the CD tab at the top of the page. Better yet, if you have a 401(k) at work, start putting extra money in that with each paycheck. Maybe you think you can’t afford to do this. But changing your W-4 will leave you with extra money to invest each payday. And, frankly, you just proved to yourself that you can live with less of your money. You did it all of 2009, and your refund proves it. Now, make that money work for you upfront.
One final note: If you did get a juicy refund this year, make it count. Allow yourself to use maybe 10 percent to treat yourself; then use the rest to pay off credit cards, set up an emergency fund, or start an IRA to save for your future. For more help on investing a 401(k) or an IRA go here.