Want to Save Money? Ignore Expert Tax Advice

Sometimes, you shouldn’t listen to the experts. And on one particular tax strategy, it could benefit you to ignore them. I’ve saved many, many thousands of dollars by not following their advice.

Rich Theory, Poor Advice?

Here’s what the experts say (in paraphrase, at least):

“You’re crazy if you want a big tax refund. You just loaned the government money for free!”

After they’re done wagging their fingers at you, they go back to studying their theory. But theory sometimes falls short when it meets practical, everyday life. And in this case, it could prevent you from saving thousands of dollars.

The problem with this expert advice is they assume you get perfect information. You don’t (otherwise many tax professionals wouldn’t exist). It’s very hard to get great information since our current tax system is old and… well, not very good.

Right now, you estimate your taxes based on your pay and marital/parental status. But what if you get a bonus that fluctuates from year to year? Or perhaps you don’t know how much you’re going to give to charity until year end. Because your income and tax deduction data aren’t centralized so some computer can automatically compute and give you real-time feedback, you don’t get the information you need to make the right decision.*

In other words, it’s difficult to calculate, with precision, the tax you owe and the tax you pay.

Say you find lending this money to the government distasteful and minimize the tax you pay from each pay check. But what if you invest the extra savings? Sounds great! So you’ll take that extra $20-200 hundred you get in your paycheck, send it over to your investment account after every pay period, and then… what? Oftentimes, the difference isn’t enough to buy shares of anything and making the transaction fee worthwhile. (Again, the theory falls short of reality.)

Chances are, you’ll forget about your extra take home pay and allow your expenses to creep up with that extra money. It’s very hard to have the discipline when you don’t really know how much you should be setting aside just in case you do owe on your taxes.

What if you’re wrong and you’re hit with a tax bill?

What’s worse: having a surprise refund or a surprise tax bill? In general, it’s good to minimize the surprise expenses in your life, especially if you haven’t been saving for it. This is why I believe you should maximize your refund.

Who is This Advice For?

  • If you can currently fund your 401k up to the max, and
  • You can pay off your credit card balance monthly, and
  • You still have cash left over after your expenses

Who is this advice not for? If you have credit card bills you can’t fully pay off monthly, then it makes more sense to make your refund as close to zero as possible. You want to pay off that high interest debt faster. Even if you get it wrong and get a tax bill, the government is lending you money for free so you can pay off that high interest rate debt. This only works if you set aside enough to pay the government the tax you owe; otherwise, it can be very costly. Again, this is all hard to do with precision because of imperfect information.

In any case, if you meet the 3 criteria above, here’s what I recommend.

4 Tips to Boosting Your Refund

(Let me be clear. I’m not a tax professional! This is just what I do for myself. You understand and take full responsibility if you use these tips and don’t get the results you want. Another thing I do recommend is having a good accountant.)

  1. W-4: On your W-4, choose fewer allowances. So if you claim an allowance of 3 now, reduce it to 2 or even 1.
  2. 529 Plan: If you have a child, start putting money in a 529 Plan if your state gives you a tax deduction. (Even if it doesn’t and you have extra savings, you should consider opening one to help pay for college)
  3. Depreciate: If you own a home and rent it out, depreciate its value. You offset some rental income (which is taxed at the ordinary income tax rate), but pay tax on that depreciation when you sell it. Basically, you are shifting higher ordinary income for lower long term tax gain.
  4. 401k: Make sure you’re maxing out your 401k. Yes, I mentioned this above, but I can’t emphasize enough the importance of maximizing your 401k. If you max out your 401k from the time you start working after college to when you’re withdrawing social security, you will become a millionaire. Even if there’s a recession. Even if you have lame returns on your investments.

You Have a Nice Refund. Now What?

I recommend you spend some, save some, give some, and invest some. The amount of your saving, giving, and investing depends on your refund. Since you’re blessed enough to have debt you can pay off in a month, max out your 401k, and have money left over, here’s my suggestion:

  • Spend 10%: Perhaps that trip you’ve wanted to take (ok, this is for larger refunds!) or show you’ve been dying to see.
  • Give 20%: This is money you were able to live without. So why not improve someone’s life? It’ll make you happy
  • Save 30%: Ok, this is only if you haven’t saved at least 3 months of living expenses for a rainy day (although I really think 6 months should be the goal). If you already have at least that, then instead of saving it? Invest it.
  • Invest 40%: Investing beyond your 401k means not only will you be a millionaire, but also that you could retire early if you want.

Just remember: 10 / 20 / 30 / 40. Simple enough?

Feeling Taxed?

You hate taxes. You hate figuring out your taxes. You hate tax day.

Because of our current system, it’s a chore to figure out how to follow “expert” advice and minimize your return. It’s no fun to think about, even less fun to read about. It sounds great in theory, but isn’t all that wonderful in your actual, day-to-day life.

I love tax day.

If you maximize your return instead, you don’t have to think about constantly adjusting your taxes. This non-expert advice helps you simplify your tax life (Our tagline is “Money Made Simple,” after all!). So when taxes are done, all you’ll be doing is getting money you learned to live without and helping yourself to reach your savings and retirement goals.

 


*Entrepreneurs willing to solve this problem, I’m looking at you. Just give me a cut of equity for this idea!

2 Comments

  • Mustard Seed Money March 4, 2017 at 9:56 am

    I really like your tips. I have a bunch of friends every year that say how can I get a big fat tax refund. I always say pay way more in taxes than you owe and you’re guaranteed to get what you want 🙂

    They normally laugh but it’s the truth. There’s only so many deductions that people are entitled to and most of the time they are taking advantage of the ones that are available to them.

    So I say if you want a big tax refund adjust your W-4 but personally I rather not give the government a tax free loan.

    Reply
    • JT March 4, 2017 at 10:37 pm

      Thanks for dropping by, MSM! Not giving an interest free loan would be optimal…actually, what would be optimal would be to borrow from the government, interest free, invest it in a rising market, then pay taxes and keep the remaining earnings (but that’s a little too risky for me).

      For me, I’m just inclined to keep it simple and view it as a savings method. But if you’re vigilant about it, you can’t go wrong with either strategy.

      Reply

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