If you're getting a tax refund, you're leaving money on the table
Here's how to turn your tax refund into the windfall it already pretends to be.
Australians love a good tax refund. Getting a deposit from the ATO feels like a yearly bonus. Better yet, a recent Finder survey of 2,000 Australians found that 47% planned to save their refund, rather than spend it.
If you're in that camp, there's a good chance you view your tax refund as a way to save money. 'What isn't seen, isn't missed,' as they say. I'm a big fan of 'Ulysses contracts' - locking yourself into a future decision that you know is good for you.
The bad news, though, is that any refund you get from the tax office this year isn't the windfall it seems - it's more likely to be a consequence of poor tax planning. When that ATO deposit arrives, it's easy to miss a simple fact - a tax refund is just you getting your own money back. There are more efficient ways to save, which we'll get to in a moment.
In essence, a tax refund means your employer withheld too much from your pay cheque each month. There are dozens of possible reasons, some of which are good, such as you claiming deductions at the end of the year to reduce your taxable income. Other reasons, however, are both negative and preventable. These include overpaying installments if you're a contractor, not informing your employer of a change in tax residency status, or your employer withholding too much after you repaid a HECS-HELP debt.
Don't leave a tip
Let's do some back-of-the-envelope calculations to figure out how much the average Aussie is leaving on the table.
In 2017, the average refund was around $2,500. We'll assume that this refund built up because your employer was missing information about your tax situation, so withheld too much. We'll also assume that investing in Australian stocks returns 9.2% a year, which was the average over the past 30 years.
If instead of letting a refund accrue, you paid exactly the taxes you owed each month, your after-tax income would be $208 higher if the $2,500 refund was spread evenly throughout the year. And let's say you invested that monthly bonus into stocks at a 9.2% annualised return. Under this scenario, you would have around $2,608 at the end of the year, rather than the $2,500 refunded to you by the ATO.
Not a huge difference, to be sure, but it adds up - over a 40-year career at that same 9.2% rate of return, we're talking about roughly $40,000 in lost income. All from that little $108 'tip' you're leaving the ATO by allowing them to invest your refund instead of you.
Everyone needs to pay what they owe in taxes, but there's no need to leave the ATO a tip. If you consistently receive a large tax refund at the end of each year, and it's for both negative and preventable reasons, you can complete the ATO's Withholding Declaration form with your employer to reduce your withheld taxes.
Whether you prefer the 'locked in' saving plan of an accumulated tax refund, or efficient tax planning with higher monthly pay, the most important thing is what you do with the money when it hits your account. Saving is difficult. While nearly half of the people receiving tax refunds intend to save it, only a quarter or so actually do. Turning a yearly refund into a monthly pay bump could be a bad move if you're more likely to save the former and spend the latter.
To avoid temptation, we recommend cutting out as much decision-making as possible. All the big banks offer automated deposit and 'sweep' functions that can take a given amount out of your pay each month and move it to a savings account. Automated fund contributions and dividend reinvestment plans are other easy ways to take the thinking out of saving and investing. Our own funds all have the option to set up a direct debit regular contribution plan.
There's truth in the saying 'what isn't seen, isn't missed'. With efficient tax planning and automated investing, your tax refund can deliver the windfall it already seems to be.
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