Why a $5,000 Tax Return Refund is Actually Good News

Why a $5,000 Tax Return Refund is Actually Good NewsThere are some folks out there who are enthralled by the idea of taxes.  The idea of working on their tax return actually excites them every year.

I’m far from being one of those people.

Taxes… borrrrring!

Unfortunately, love ’em or hate ’em, if you’re in the U.S., you’re stuck with doing a tax return every year.

There’s a part of taxes though that I don’t really get.  It’s the idea that if you get money back on your tax return, you did something wrong.

And the higher your refund, the more your year was botched.

This year we got around $5,000 on our tax return (between federal and state).  That’s quite a bit more than we usually get back.

Let’s talk about why I disagree with this advice and why I think a healthy refund is actually a good thing.


The Zero Dollar Tax Return

Why a $5,000 Tax Return Refund is Actually Good News - The Zero Dollar Tax Return
What did zero say to eight? Nice belt.

A big push with doing your taxes is to try to get your tax return liability as close to zero as possible.

On one end, you obviously would prefer not to owe anything to Uncle Sam.  And that makes sense… who really wants to be stuck with owing the government some bucks at the end of the year?

Not this guy, that’s for sure.

But on the other end of the spectrum, you’re not supposed to want to get a big refund back.

The encouragement is to use the IRS Tax Withholding Calculator to adjust how much you have taken out of your paycheck at work to keep your tax return close to zero.

And why don’t you want to have a big refund on your tax return?

Because that means you just gave the IRS an interest-free loan for the year.

Or so the logic goes… but I ain’t buyin’ it.


My problem with the no big refund advice

Why a $5,000 Tax Return Refund is Actually Good News - My problem with the big refund advice
Uh-oh, it’s time for a little math to work on this thought!

The idea is that instead of giving the government an interest-free loan, you should be investing that money elsewhere.  After all, even a crappy bank interest rate of 0.01% is better than the 0% you’re getting giving it to the IRS all year.

For example, my tax return (federal and state combined) yielded a refund of around $5,000.

Ally Bank is the online bank I use for my emergency savings – my cash stash so to speak.  As I write this, they’re currently paying an interest rate of 1.45%.  That’s over 48 times better than the 0.03% my credit union is paying!

So let’s go with the idea that I spread out the contributions throughout the year and deposit it into my Ally account.

With my $416.67 monthly deposit compounded monthly at a 1.45% interest rate, that would turn my $5,000.04 deposit into about $5,043.

That’s a gain of about $43 – yeah, I’m good at this math stuff!

That means I would have lost $43 over the course of the year by “loaning” that money to the government.  And sure, $43 is better than nothing, but it’s also not going to be what puts you over the top for your retirement plans.

And yes, you could put that money into something a little riskier, like the stock market, and possibly have gotten a bigger return.  However, it’s also possible that it could be worse depending on how that year goes.

Sounds good, Jim – I’ll take my interest any way I can!

I get that.  But for this to work, you would have to be so focused that you’re planning ahead at the beginning of the year and actually putting that money into your account in the first place.

Most of us aren’t that disciplined.

Hopefully, you’re on track automating your savings and investments.  However, are you really anticipating how your tax return is going to go a year in advance and investing that money throughout the year?

Unlikely.  There are probably a few of us that do that (props to you!), but most folks really wouldn’t fall into that category.

And that being the case, it’s very likely that money would instead slowly disappear into routine spending throughout the year.

Yes, that’s the exact opposite of paying yourself first.


The Route to Retire Logic

Let’s look at this from a different angle, however.

What if you don’t optimize your taxes to try to stop from getting a nice refund back from your tax return?

Now you’re “stuck” with something like my $5,000 refund.

That means I failed the mission, right?

Why a $5,000 Tax Return Refund is Actually Good News - The Route to Retire Logic
My brain’s very complicated… you wouldn’t understand. I’m like a genius that no one but myself seems to recognize! 😉

I don’t think so.  We have a strong personal savings rate – close to 60%.  That’s relatively high – especially since that’s with Mrs. R2R not working.  Scraping more off the top can be a struggle sometimes for us.

However, a nice lump sum of $5,000 from a healthy tax return is a little bit different.  It’s almost like a small windfall.

We can actually put some of that toward the cruise we recently booked and still have enough to invest a sizable chunk.

Instead of letting that money disappear into our regular spending throughout the year, we have other plans.

Once the refund came in, I immediately moved it over to my online account at Ally.  That will give it about 6 months to grow and gain some interest before we need to pay off our cruise.

In theory, we’d then pull that money out to pay for the cruise, but that’s really not going to happen.  That’s like my black hole for money – once it’s there, it stays there.  It is for emergencies after all.

In other words, we’ll now benefit from that chunk of money being in our savings for the coming year… something we likely wouldn’t have made happen otherwise.


Side note on our tax return refund

Why a $5,000 Tax Return Refund is Actually Good News - Side note on our tax return refund
Not quite this easy to turn a property into a cash register, but with a little education and effort, it’s definitely possible. Cha-ching!!

To some of you, $5,000 is a tiny refund.  To others, however, you’re probably wondering how we got back a nice amount like that.

The answer is actually pretty simple.  Rental properties and small businesses.

If you have delved into either category of income, know that there are great incentives for doing so.

The government encourages those who provide housing or start their own businesses.

Rental properties allow you to make money from rental income but still be able to show a loss on your tax return… legally.  Depreciation can be a landlord’s best friend!

Small businesses are very similar in that you can reap the rewards of being able to write off expenses you wouldn’t be able to otherwise.

As we’ve continued to go down both of these roads, we’re seeing more opportunities to make money while paying less in taxes.

If you haven’t veered off a regular W2 income yet, it’s definitely something to consider.  You might be surprised at just how many great opportunities are out there!


Do you aim for a tax return of close to zero or do you have a show me the money!” philosophy?


Thanks for reading!!

— Jim

You know you wanna share this!!

22 thoughts on “Why a $5,000 Tax Return Refund is Actually Good News”

  1. I aim to get to as close to $0 but that’s because I’m self-employed and have to make estimated quarterly tax payments. You can adjust those on the fly far easier than if you had a job and needed to hassle someone in HR to adjust your withholding.

    That said, there are plenty of things in life that are “better” but financially suboptimal. The debt snowball comes to mind. You want to do whatever leads to better outcomes and human behavior doesn’t follow rational patterns. If leaving yourself a windfall of a tax refund leads to greater savings, that’s better.

    1. That makes sense on the quarterly tax payments. It’s also a good reminder that as my side hustles are starting to make some money, I’ll probably need to look at that as well. Thanks for that, Jim!

      Great comparison with the debt snowball. The idea doesn’t make sense to any mathematicians in the room, but if it helps to move ahead, then it’s a viable option.

      — Jim

  2. I have a show me some (but not too much) money philosophy when it comes to tax returns. 🙂

    Like Jim Wang above, I also pay quarterly tax payments and I shoot for getting some money back as a safety margin. I don’t want a fat tax bill with penalties if I have to sell a bunch of stock late in the year for some reason.

  3. If everyone internalized the importance of math (and was capable of remembering it dispassionately at all times) in their lives, we’d all act rationally. But sometimes we don’t get enough sleep. Sometimes our kids are screaming. Sometimes our co-workers are mean. And sometimes all of that is true all at once… and we don’t make perfectly rational, mathematically correct decisions. 🙂

  4. I couldn’t agree more. Back before financial independence and our early retirement we enjoyed big refunds. I also did the math and sometimes the cost exceeded $43, in fact the number got up to a couple of hundred dollars. The math was different back when interests rates were much higher. But still having artificially low take home pay instills a sort of forced scarcity that makes the whole frugal lifestyle easier to pull off. It is a form of lifestyle deflation that painlessly increases the savings rate and at the same time makes the necessary vacation or fun purchase fit into an otherwise austere budget. Now that I have more than I need and also have to do quarterly payments on my side gig income I don’t shoot for a refund. But in the accumulation phase I think it is a good savings hack even though most bloggers in this space do not agree with us on that!

    1. Thanks, Steveark – that’s a great point on interest rates making a difference. Right now, with them being so low, it’s not like you’re really missing out as much as you would otherwise.

      — Jim

  5. I aim for $0, but rarely get close. Last year, we got about $1,000 back.
    This year we need to send in $10,000. Yes, that’s 4 zeros. I made too much money online and didn’t send in enough estimated tax. No penalty so it’s not a big deal. I guess it’s like an interest free loan from the government. Thanks Uncle Sam.

  6. I aim for 0, but the alternative for me is, like some others, a large tax bill not a refund. We just have too much coming in from my wife’s consulting business, investments, and other non withholdable sources. So the goal is just to avoid estimated tax payments by jacking up work withholdings.

    1. Sounds like a good problem to have! I like the idea of increasing withholdings to avoid the tax payments. I need to dig into that some more – seems like a viable option for making life a little less complicated.

      — Jim

  7. If you had that money invested in the stock market last year instead of a bank the market made 21%, there is a difference. You would have made far far more than $43. You of course didn’t have the $5000 the whole year, so it wouldn’t have been a full thousand dollars. But you missed out on probably $400 – $500.

    To be clear, I’m not criticizing – as long as you’re comfortable with getting a refund then that’s what works best for you. You should stick with it then. Everyone sets up their systems that work for them and in the end we’re all doing well here.

    Personal finance is indeed personal 🙂

    1. I’m all about discussion so I’ll take this comment any day! 😉 Very true that the stock market had a great year, but it was also very unusual and could have been a market turn just as well. Regardless, I generally take any refund and move it into my savings account since I’m building up my reserves for my FIRE date.

      That makes it pretty irrelevant to my situation, but it’s still good for discussion for others. A wise man recently told me that personal finance is indeed personal. 😉

      — Jim

  8. I usually have the opposite problem- I owe! I think about paying taxes in instalments but it just doesn’t seem worth it. I usually get an RRSP loan (Canadian registered retirement account) so I can reduce my taxable income further.

    This year I did the usual and after the deadline realized I put too much in, because I forgot about $3500 in contributions I had made to a robo advisor account. So I’ll have a refund, and will use it pay off the RRSP loan. I agree, when you’re dealing with plus or minus 5,000 it’s not worth optimizing your taxes.

    1. Owing’s no fun! 🙁 As some of the folks have been commenting about estimated quarterly payments (something I haven’t needed to do yet), I started doing a little digging. It looks like here in the U.S. if we underestimate on the quarterly payments, we could be subject to a wonderful penalty at the end of the year. Is that similar in Canada?

      — Jim

  9. Thanks for the reply Jim and again, I’m not criticizing your choice. But I would also add that it’s not as irrelevant as you might think. Sure, the market doesn’t go up 21% every year, but it does average around 7-8%. Eight percent of $5k is still $400 bucks. That’s why you have your money in the market – it’s the best place to have your money for growth.

    You said “the market could have also turned down”. But it didn’t. And most years it doesn’t. And over time it goes up 7-8%, which is why we FIRE folks all invest in it. It’s the best place for our money.

    When Uncle Sam has your $5000 for a full year, it gets eroded by inflation, you get zero interest, and you can’t access the money if you need it. It’s locked away from you. It’s like a CD with no interest. You get back less than $5k after inflation.

    If you put the money under your mattress, it would still be eroded by inflation and earn zero – same as Uncle Sam having it – but at least you could get to it if something happened during the year. It’s liquid and accessible.

    In my 20+ year path to FI I have easily made 10’s of thousands of dollars or more in the market by keeping my money during the year, having it invested in the market (which goes up over time – always), and not allowing Uncle Sam to hold it hostage from me, only to give it back the year after with nothing extra. I actually take interest free loans FROM Uncle Sam by slightly underpaying, and pay him back next year, like Joe said in a comment above. That’s using free money that’s not mine to make extra money.

    I would just add one last thing, you said in your post “Instead of letting that money disappear into our regular spending throughout the year, we have other plans.’

    Now you already have a 60% saving rate which is booyah! You guys are killing it! But if you just took that $5k during the year and added it to your savings rate, you’d be even higher. Just don’t spend it – automate it to invest. You’ll never see it. You obviously didn’t need it anyway to live, because you weren’t getting it.

    Again, just trying to add a different perspective to the conversation, hope this doesn’t come off as critical because it’s not intended that way. We’re all trying to optimize our systems and learn from each other. You guys are used to overpaying and getting it back the next year, and that’s the system that’s worked for you. So being that you’re obviously winning in life, don’t fix what ain’t broke!

    1. I definitely see your points, AF. And I do agree that investing your money in the market will help build it.

      In my case, though, that money needs to be in a safer place right now (Bucket 1, so to speak). Right now, we’ve actually built up our tax deferred positions higher than we should have because of things we couldn’t pass up (like a great employer match on our 401(k) plan). Because of that, we just need to build up our “safe” money before I quit my job.

      However, your advice is very sound for others who might not be in the same position as I am. No worries about coming off as critical – I enjoy the conversation! 🙂

      — Jim

  10. You can definitely make quarterly tax payments in Canada. There’s no penalty if you undercontribute for the year (you’ll just owe it all at tax time) unless you are late in paying taxes owed.

  11. Oh no, I’m one of “those” people. I have a lot of fun doing taxes and they were really complicated this year. Yes, even my husband calls me a geek, lol.

    I don’t even go for zero I go for owing taxes each year. For us personally it’s all in a savings out of sight and out of mind, any refund would go the same place and we wouldn’t feel a difference from it.

    But that’s the thing about personal finance. It is personal and each person has to do what works for them. The feeling of a refund being a windfall is hard to put a value on. It is very much worth the small amount of interest that might have been earned if not spent for many.

    1. Haha, let me know if you want to have a lot of fun doing my taxes next year as well… I dread it! 🙂

      You’re so right about it being whatever works best for each person – to each his (or her) own.

      — Jim

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