Is your Big Tax Refund Poor Financial Planning?

Written by admin on December 5th, 2010

Big Tax Refunds=Poor Financial Planning

You’ve heard this every spring in the lunch room at work. Joe bragging about getting a 00 tax refund. Jenny tops him with a 00 tax refund. Then Jack whose wife had a baby during the year and bought a new house tops them all with a 00 tax refund. Over in the corner smiling to herself is Joan who had to pay an additional 0 in income tax. With all the others getting big tax refunds what is so special about Joan’s situation?

And why was Joan smiling? Well because after last years 00 tax refund Joan and her husband decided they didn’t want the government holding their money for the better part of a year and they earned nothing on the funds. How could they tune-up their investing and saving plans so they did in fact earn something on the prospective tax refund? Importantly, they wanted a plan so their earnings would compound and over time they would have a comfortable nest egg with the annual tax refund.

Their first step was to review their savings and investing plans. They found that Joan was not contributing enough to her 401k to get the maximum company match. So she increased her 401k contribution from 3% to 5%. The gross cost on her ,000 annual salary was 0 but since it reduced her taxable income by 0 her net cost was about 0. The company matched 50% up to 5% so the company added 0 to her account. Not bad investing 0 and increasing the amount invested by about 00.

Joan’s husband was contributing 6% in his company’s 401k plan and was getting the maximum company contribution of about .60 cents for every .00 invested.

They decided to start Roth IRA’s with the balance of the prospective tax refund. Although there was no immediate tax benefit, the investments would grow over time and as they got raises they could increase the amount invested until they reached the allowable yearly maximum. The big benefit would. be after age 59 ½ they would pay no income tax on any withdrawals from the Roth IRA.. So in the first year, they had 0 a month automatically deducted from their checking account, with allocated to each Roth IRA. So in one year each Roth IRA was funded with 0. An additional benefit of the Roth IRA was they considered them an emergency fund as there was no penalty for withdrawing the funds.

Now you ask where did they get the money to fund the Roth IRA’s and the added contributions to the 401k? After some calculations they submitted new W-4 tax withholding forms. They increased their deductions to equal the amount of the anticipated tax refund. Now their take home pay was increased, but with the extra 2% (before tax so the real cost was about 1.70%) for Joan’s 401k and with the 0 a month automatically deducted from their checking account to fund their Roth IRA’s their collective take home pay stayed about the same.

But look what they accomplished. A 401k with an additional 00 invested and Roth IRA’s

with an additional 0 each invested for a total of about 20. All instead of a tax refund of about 00. And the investments will continue to grow and compound. When asked if she missed the big tax refund Joan said, “I don’t even remember what we did with the tax refund last year. I think we paid some bills and went out to eat a few times and it was gone. I’m real happy with the change.”

What about you? Which group are you in the lunch room? It’s never too late to take control of your tax refund. Consider turning it into a long term benefit rather than the one time windfall. After all it’s your money and your future.

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