It’s hard to believe tax season is fast approaching. Tax season is either exciting, stressful, or just plain annoying depending on your financial situation. Many Americans who are owed a tax refund eagerly anticipate tax season. Let’s be honest here; we were once those people, but thankfully our eyes were opened. By the end of this blog, yours will be too.
In a nutshell, a tax return is essentially an interest-free loan from you to the government. At the end of the tax year, the government pays back the money you “lent” them. To some that may seem like no big deal. Quite frankly, some people probably prefer that lump sum because lump sums are hard to come by. If you were to borrow money from the government, we can guarantee you’d pay it back with interest. So why allow the government to borrow money and not pay you interest?
At ELP Budgeting Services we pride ourselves on educating our clients so their ELP Budgeting Services monthly savings column can grow exponentially. The hard truth is that a tax return is hindering your wealth.
Number’s Don’t Lie.
Let’s break down the above infographic to prove this truth.
Each year Kim receives a $10,000 tax return and deposits it entirely into her savings account. Her savings account earns 0.06% APY. After 30 years, Kim will have $302,806 meaning she only earned $2,806 in 30 years.
Like Kim, each year Stacey also receives a $10,000 tax return. She immediately invests the entire $10,000 upon receipt. Stacey’s investments earn 7% annually. After 30 years she will have accumulated $944,608.
Jasmine does not receive a tax return. She chooses to not overpay her taxes and take home $833 more per month, or $10,000 over the course of the year. Each month Jasmine invests the $833. After 30 years, with a 7% annual return, Jasmine will have $974,154. While Stacey and Kim earn on the same order of magnitude, if you’re like us you will gladly take Jasmine’s extra $29,546.
What conclusions can we draw from this example?
- Investing outpaces saving.
- Compound interest is optimized with time.
- Large investments do not necessarily compensate for time.
Furthermore, Americans who receive a tax return like Kim, and deposit it into savings, are more likely to spend the lump sum. Rarely would the full $10,000 deposited in the beginning of the year be in the account at the end of the year. In addition, those like Stacey who have some investing habits may receive a lump sum and only partially invest it. The people with the best chances for wealth generation are those like Jasmine who are disciplined to regularly invest and not tempted with dipping into large sums. However, if Jasmine spends her extra $833 a month she’s worse off than Kim. Ultimately, as we concluded in our 3 Budget Saving Mortgage Considerations (That Could Make You Wealthy) post, wealth is dependent on making the right decisions at the right time.
Ready to stop lending money to the government interest-free? Here’s 4 steps to prevent taxes from hindering wealth:
- Estimate your federal tax withholding using the IRS calculator.
- Estimate your state tax withholding using the appropriate calculator or form.
- Adjust your employer W-4 based on number 1 and 2 as to not have too much or too little tax withheld.
- Invest your increased take home.
We can help.
ELP Budgeting Services strives to prove to each valued client that wealth is not out of reach. An accumulation of small wise decisions such as adjusting tax withholdings can make the difference in a wealthy future. We’ve developed our Investment Focused Budgeting Package to allocate all investment avenues for our clients. Ready to talk about all the ways ELP Budgeting Services can help you acquire wealth? Get started here.