The Internal Revenue Service (IRS) reported that the average tax refund this year is around $2,852, about $75 more than in 2023 according to the most recent data from the institution. Depending on how you look at it, it can be considered a lot of money or a little money. It all hinges on how you use that extra check that you didn’t expect and that you didn’t have contemplated in your budget.
Usually, experts recommend allocating that cash to pay off debts or save it for the future. It’s true that for some smaller debts, that $2,852 can have a big positive impact by reducing debt and interest, or decreasing the size of the monthly payment for the rest of the loan term.
Many people often consider the tax refunds as money to spend superfluously, buying things that they otherwise would not have acquired with their normal budget. These behaviors are understandable; with an extra $30, they can range from buying a state-of-the-art LED TV to using it as a down payment to change the car. “Why not?” is the question that comes into your mind if that’s an idea that attracts you..
As of the end of April, the IRS had processed about 141 million tax returns and sent about 261 billion in refunds to its taxpayers, 2.2% more than last year. Here is an interesting way to turn that new money into a significant amount: the trick is to keep it for a few years, and we tell you how to do it.
Turning Your Tax Refund Into Retirement Savings: Such a Good Idea
To give you an idea of the positive impact that adding that money to your retirement savings can have, we present an example with a person named Braad Peett, but not the actor; this Braad simply has a slightly similar name. It’s pure coincidence.
Braad is in his early 40s and has started saving for retirement at precisely that age. Although you should have done it sooner, it’s never too late to start a retirement savings. Braad plans to save about $4000 a year, which is equivalent to 15% of its annual income. To calculate how much you’ll have saved by the time Braad reaches his full retirement age, we’ll assume a hypothetical annual growth rate of those savings of 5% – a reasonable investment in a stable market for long-term investments.
Using a compound interest calculator, Braad will have saved approximately $114,066.57 by the time he reaches full retirement age. So far, Braad has not added the $2,852 of that refund that he will receive in 2024 from the IRS.
Let’s say that, hypothetically, I would receive a similar amount of tax refund every year from now on. If you decide to add that amount to your retirement savings as an additional contribution, the total annual contribution would be $6852, that is, the $4000 that you already contributed initially plus an additional $2852. Using the same 5% compound interest rate, Braad would have saved approximately $194,399.53 for his retirement when he reaches full retirement age.
Distributing your tax refund in several parts could be the solution
Matt Schulz, chief credit analyst at LendingTree, said paying off debt and contributing to savings are the two strongest actions one should do with their tax refund. Although he did not mention retirement saving as a possibility of investing that money, he stated that people should not prioritize debt over savings, or vice versa, but learn to prioritize both things simultaneously.
For example, if you pay your credit card to zero, but you don’t have any money saved, what will happen the next time an unforeseen event occurs, such as a flat tire or a visit to the veterinarian for your dog, is that the expense will return to your credit card, and you will be in debt again for a long time. So if you can spread your tax refund across multiple purposes, you’ll be making the most balanced decision for all of your finances. You can divide it between retirement savings, common savings for unforeseen events and debt repayment.