How to Win at Money with Tax Refunds

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Have you heard the one about the smoker and the Ferrari?

A woman sees a man smoking and asks how many packs a day he smokes, how much each pack costs, and how long he’s been smoking.

Once he tells her, she does some quick back-of-the-envelope math and informs him that if he had invested that money rather than throwing it away on his cigarettes, he could have bought a Ferrari by now.

The man then asks the woman if she smokes. When she replies, “No,” he asks dryly, “Where’s your Ferrari?”

This joke sums up my feelings about most of the tax refund haters out there.

Refund Hater: “Why would you get a refund? You’re just giving the government an interest-free loan! If you were getting that money in your paycheck, you could be investing it for yourself.”

Me: “How much more are you investing since you’re not receiving a refund?”

Refund Hater: “Oh…uhh…well, I haven’t quite gotten around to that part yet. I’ll be able to do more whenever I want, though, because I’m keeping more of my money!”

Me: *side eye*

Now, I know this doesn’t describe everybody (and certainly none of you guys, right? :)). I just want to let everyone know…

Public Service Announcement:

Tax refunds do not automatically signify poor financial planning. In fact, they can be great tools to help you reach your financial goals.

Slight Income Increases vs. Windfalls

It’s no secret that when people get slight increases in their pay, they generally increase their spending.

Lifestyle inflation is a beast.

In contrast, when people get a windfall, they tend to be more mindful in how they use it. For example, in 2001, President Bush signed a bill cutting taxes to stimulate the economy. The plan included tax rebates of up to $600.

A study by the National Bureau of Economic Research shows that people overwhelming used the tax rebate to advance their financial goals (saving or paying down debt), rather than spending it.

This makes sense, right? How easy is it to spend a little extra money we receive over the course of a month without realizing where it went?

It’s harder to mindlessly spend a large chunk of money (although I know some people can do it). Generally, you’re going to be much more thoughtful and intentional about what you do with a windfall.

In other words, the logic behind the aversion to tax refunds makes sense, but the truth is, most people likely would spend the increase in their paychecks, rather than using it to further their financial goals.

I recognize that if you have a budget, you’re much more likely to be intentional with your money, but unexpected expenses still can come up.

When we have a little more money, we also tend to justify or brush off spending on little things. “Spending a little more on xyz this time won’t hurt…”

…except when all those little expenses add up to a lot of money at the end of the year—money that could have helped you reach your financial goals faster.

The trouble with making good money decisions

I recently finished the book Essentialism: The Disciplined Pursuit of Less by Greg McKeown. One thing McKeown talks about is the importance of making one decision that eliminates one thousand later decisions.

He also discusses a psychological phenomenon called decision fatigue: the quality of our decisions tends to suffer the more choices we make.

I think you see where I’m going here.

How often do you get paid? Once a month? Twice a month? Bi-weekly?

That’s 12 to 26 times you’re deciding how to use any slight increase in your paycheck from not getting a refund. Hopefully, you’re choosing 12 to 26 times to use that money to pay off debt or save for a down payment or [insert your financial goal here].

Research shows that most people aren’t.

Further, even if you start the year making good decisions with that slight increase, the likelihood of you continuing to make such good decisions diminishes as time goes on due to decision fatigue.

Most people are setting themselves up for failure.

When you get a refund, you can make one good decision and eliminate the need for the 12 to 26 other decisions.

Why we get a tax refund

When I started my job, we were concerned about taxes. Up until that point, we had never made any real money, so we never had to worry about taxes before.

Now that we were going to be bringing in six figures, we were afraid that we would have a huge tax bill.

We did the IRS’s withholding worksheet and decided that I wouldn’t claim any exemptions on my W-4. We even had an extra amount withheld from each paycheck just to be on the safe side (which turned out to be complete overkill).

That first year, we got a pretty nice size refund. We were already thinking about buying a house and had started saving for a down payment.

One good decision in 2015: We put the refund straight into our savings account and gave our down payment fund a nice boost.

When Mr. TMG started his job, he also claimed no exemptions on his W-4. I adjusted mine to remove the extra withholding but still claimed no exemptions.

One good decision in 2016: We put our refund that year in our down payment fund, as well. Boom!

We bought our house in mid-2016 with a nice down payment. That same year we had Little TMG and began to shift our focus to getting out of debt.

In 2017, we received a hefty tax refund because we still claim no exemptions but now have a house and baby and give 10% of our income away.

One good decision in 2017: We put that refund toward our debt and jump-started our debt payoff journey.

This year, we’ll receive another large refund for the same reasons as last year and will again use the money to pay off debt.

We prefer to get a large chunk of money during tax season that we can immediately use for our financial goals (our current goal is paying off our huge debt burden).

Rather than having to make decisions every month about how to use a little extra money in our paychecks, we make one good decision each spring about what to do with a lump sum of money.

Some people cringe when I talk about our tax refund (especially my accountant friends), but this strategy has worked for us so far and is helping us to reach our financial goals.

If you ask me, our tax refunds have us #winning.

How do you feel about tax refunds?

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2 comments

Megan Nichole | The LaziMILLENNIAL Movement

I will ALWAYS be here for the lump sum 🙂

Lump sums ftw! Will you be getting a tax refund as well?

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