As we approach another tax deadline, the IRS has been churning out data on average tax refunds already. The average tax refund in the most recent year was $2,815. That’s a huge infusion of cash landing in the laps of a lot of taxpayers. As contrary as it may seem, however, receiving a tax refund is not a good thing. A tax refund is simply getting your hard-earned money given back to you with 0% interest (actually, a negative return when you factor in inflation erosion). You overpaid your taxes throughout the year and the result was an interest-free loan to Uncle Sam. Your tax refund is you getting your loan back – without any interest.
The result of this false payday is often referred to as “tax refund windfall syndrome” (by me, at least) – where taxpayers are handed a huge check that results in new positive cash flow that they normally don’t have – so their first urge is to go out and spend it on a bunch of stuff that they don’t need. To “treat”, or “reward” their-self as if they were betting house money.
What if those refunds were treated with wise restraint instead? Refunds are cash that was not counted to live on over the previous year, right? So what if 100% of refunds were (appropriately) funneled directly in to personal savings and left there for good? And in putting your tax refund to good use, you were guaranteed a positive ROI.
It’s hard to get an apples-to-apples comparison when the metrics that are reported vary, but some back of the napkin math paints just how massive of an impact this one simple little act of discipline and restraint could have:
- The median U.S. household income recently was at $67,521 (pre-tax).
- The average tax refund for the same year came it an $2,815.
- Take that average refund ($2,815) and divide it by the average household income ($67,521), and you get a refund/income ratio of 4.2% – and higher, if you were to look at income in a post-tax sense (tax refunds are post-tax dollars, of course).
Now, 4.2% does not sound like a lot, until you consider that the average personal savings rate for Americans has been around 5-7% for a number of years recently, it’s a lot.
In other words, American tax refunds are almost as much as annual personal savings, on average!
If we assume that those refunds are going anywhere but personal savings, the act of diverting them in to personal savings instead could result in more than a doubling of the personal savings rate, on average.
1 check, 1 deposit, double the savings. Your mileage may vary in the results, but the advice stays the same.