March 10, 2023

Tax Refunds Aren’t What You Think

By: Patrick Nalepa

There tends to be two types of people in this country when it comes to filing their taxes. Those that seem to “always” owe the government money when it comes to filing their taxes and those that “always” receive a tax refund. The ones that owe on taxes, typically delay as long as possible to file due to procrastination, while those expecting refunds try to file as soon as they have all their tax documents so they can get their “annual bonus” as quickly as possible. Don’t get me wrong, it is nicer to receive money when filing taxes than owe, but hear me out as to why it is better financially to actually owe the IRS when it comes to filing taxes.

Yes, my hot take around taxes is that it is better financially to owe the government than it is to receive a refund (assuming you didn’t intentionally under-withhold or incur penalties due to negligence). To fully understand this we need to take a step back and look at why some individuals owe on their taxes and some get a refund. When you file your taxes, you will be required to pay the government (federal or state) additional funds if your calculated tax obligation for the year is MORE than what you paid the government during the year. These payments are typically automatically made on your behalf to the government from your employer. This makes it fairly simple and straightforward. However, sometimes due to life circumstances unique to the individual these paycheck withholdings can be thrown off. If they end up being LESS than your annual obligation determined on your taxes, then you will have to write the government a check. This helps makes the government “whole” as it pertains to your taxes each year. But it means that for the last 12 months, you were able to use a little extra cash each month interest free to fulfill your monthly obligations.

On the flip side, if you are receiving a refund from the government on your taxes it is because you overpaid your obligation during the year. Have you ever noticed that on tax refunds the government doesn’t apply interest on the amount they owe you? Given nearly double digit inflation last year, if you receive a refund this year you have really been hit by a double whammy – inflation and no interest. On top of that, most Americans view a tax refund as a bonus and spend it frivolously, instead of viewing it as what it is, the government giving them back their own money. But what if I told you, I have a strategy for you to make up for the lost interest and put that refund to work for you?

The average American refund is around $2,800. Now instead of viewing the $2,800 as a bonus to be spent on a vacation or an impulse item you’ve been coveting, the secret is simple, invest it. Take that money and have it work for you year-over-year. If you received this same $2,800 refund over 20 working years and continually invested it, earning a moderate 6.5% rate of return, you would accumulate $108,000 during that span without using a single dollar from your pocket. If you continued that practice over another 20 years (40 years total), you would have nearly $491,769 in that account. So this year, instead of feeling like you received a bonus from the government, see it for what it is: a repayment of your funds and invest it so that you can get ahead. And as you head into a fresh 2023, look to break as even as possible on your taxes so that the government doesn’t get to use your funds interest free for an entire year. Now don’t get me wrong, when filing your taxes, I personally believe it to be best to be as close to net $0 as possible. No refund and no obligation to the government. But if you are like most Americans, you will be receiving some amount in a refund, so you might as well make that money work for you.

While this is not tax advice and I am not a tax professional, as a financial professional I help countless individuals and families with these types of situations every day. If you are interested in learning more about how to invest your tax refund or have questions please don’t hesitate to reach out, [email protected]. Happy Tax Season!