When it comes to finances this time of year, something people
are thinking about is taxes. You see the commercials on TV for all of the tax
preparation services and software. And they all look so happy – personally, I
don’t know anyone is actually happy about taxes, except for, perhaps,
the tax accountant.
According to the IRS, the average refund last year – 2015 returns
for tax year 2014 – was $2,797. That figure was basically unchanged from the
prior year. I’m sure that everyone who gets a refund is pretty happy about it.
Well, certainly happier than the people who have to pay – because that’s never
any fun!
Take a moment and think about money in general – not just
taxes. Perhaps you have a dollar bill lying on the table. What is it doing? Is
it just laying there? Is it really just laying there?
Money either works for or against you. Money works for you
by generating a return, such as interest from a deposit account. Money works
against you due to interest you have to pay on a loan, or simply just
inflation.
If you left that dollar on the table for a year, it wouldn’t
have the same purchasing power. If inflation is 3%, then the purchasing power
of that dollar a year from now would only be 97 cents.
Besides inflation, there is the opportunity cost. That is,
the interest that dollar could have earned, but didn’t because it was just on
the table.
So what does all of this have to do with taxes?
Let’s consider that for an entire year, you don’t have
access to that money, not earning interest for you, and inflation is reducing
the purchasing power. What does that mean in real money?
Consider opportunity cost. Let’s suppose that instead of
earning zero while the government has your money, you could have earned 5%.
Taking the average 40 year old person, and going until the
normal retirement age of 67, the figures look like this:
|
Refund / Yr
|
$2,797
|
|
Total Amount to age 67
|
$75,519
|
|
Assumed Interest Rate
|
5%
|
|
Total Amount with Interest
|
$152,910
|
|
|
|
|
|
$77,391
|
The table above shows that the total amount of the refunds
to age 67 is over $75k. But once you factor in interest, that amount goes to
almost $153k.
Over time at a hypothetical 5% return, the money could earn
over $77k!
That’s called having money work for you!
In order to recapture this lost interest, follow these 2
steps:
- Use the IRS withholding calculator or any of the numerous calculators provided by various the tax preparation software companies. The link to the IRS calculator is here.
- Set up auto deposit from your paycheck to the savings vehicle of your choice. You’ll be getting extra take home pay, so make sure you save it.
Even if you don’t get the hypothetical 5% return in the
example above, have it earn some interest. Having your money work for you is
better than having it work against you!
