The PF blogging community would be so ashamed of me: I’m getting a large tax refund.
Here’s the thing: At the start of 2020, I didn’t know how much I’d be able to put into retirement that year; and I wasn’t sure whether I’d get all the same deductions that I did in 2019. So despite getting a sizable federal tax refund, I didn’t change my estimate tax amounts.
Okay, admittedly, this was also part laziness. It sounded like a lot of work — and since some of it would be guesswork, it would be a lot of work that was also fraught with anxiety. No thanks. So 2020 Abby left it up to me, 2021 Abby, to sort it all out. Thanks, past me.
And of course, then COVID happened. I couldn’t exact go out or travel, so I suddenly had fewer expenses. As a result of that plus a small raise I’d gotten, in 2020 I was able to put $6,300ish more into retirement than I had in 2019. Which of course, lowered my taxable income. And had I done five minutes of research, I would’ve found that, yes, I would get all the same deductions as the previous year.
As a result, I was apparently vastly overpaying my taxes. My federal refund will be $3,464, and my state refund will be $1,231.
In my defense for the state refund: It normally would have been “only” an $831 refund. But it turns out an organization I donated to with part of the first stimulus check is considered a Qualifying Charitable Organization by the state, so I got a 1:1 tax credit for donations up to $400.*
And with no change in pay for 2021, I can expect to owe about the same amount in taxes this year as last. Well… probably.
*This year I’ll do the same, but by diverting some of the money I’ve been sending to Feeding America to local QCO food banks instead. People in need get fed — but so do my retirement accounts.
The (social butter)fly in the ointment
My friends and I want to go to Vegas once everyone is fully immunized. (The last two members of the group got their first shot on Saturday! Woot!) This will mean dipping into my vacation fund, which means afterward I’ll go back to putting in $100 a month. So that’s an extra $100 out of potential retirement contributions each month.
Also, my friend Brandon is pretty hell-bent on making up for lost time, so he’s proposing all sorts of activities that will mean I’ll need start allotting money for going out again.
So that will also mean less money for retirement contributions. But I do want to be social again, so it’s worth a little sacrifice. And of course — at least as long as Aaron and I are working — I won’t be Ubering to multiple dates each week, so I probably won’t need as high a budget as I had at the beginning of last year.
All of that being said, now that I’ve refigured my estimated taxes, I’ll have an additional $300 a month to play with. That should cover the blast-from-the-past spending categories — well, once Brandon calms down a little.
Where these refunds will go
I’ve already gotten my state refund, which went into my Roth. I’ll finish maxing that out with the federal refund (leaving $1,799 to spare).
That’s important because my monthly budget has a line item for a $500 Roth contribution from my personal checking account. Now that the Roth is replete for the year, those $500 can stay in my business account, allowing me to put them into my SEP or 401(k).
To be clear, this doesn’t mean I’ll be contributing $4,500 more than last year. In 2020, I also maxed out my Roth early (also thanks to tax refunds) — but not til July.
This year, the last contribution (other than the refunds) will have been March’s. So that’s four extra months that I can potentially (assuming no huge credit card bills) contribute $500. Woot!
Small but steady wins the race
I know some people like large tax refunds. It’s a way for them to save money, which they then get once a month to cover necessary expenses or pad savings.
And hey, if that’s your method (and you don’t think automated transfers would work) then buddy, you go ahead and keep that withholding high and enjoy your annual big check.
But for me, refunds are a problem for two reasons.
First, my SEP/401(k) contributions have to come from my business account, but my tax refunds go into my personal account. Technically, I could deposit them into the business account as an owner contribution but… It would complicate the business return that I finally got simplified enough to do myself (a $500 savings). So… no.
This year, I’ll get around this by putting the rest of the refund into checking rather than savings and withholding the same amount from my employee paycheck as a 401(k) contribution.
But besides making my monthly money math more complicated, the idea of waiting for a refund for a full year before adding it to retirement brings me to the second problem: I’ll lose compound interest.
As many a personal finance blog post has espoused, the sooner you get money into your investment or retirement accounts, the more compound interest can do for you. Sure, putting in the money a few (or even several) months later may not make a huge difference — but if my balance is lower during a strong market uptick, it actually would.
So it’s best for me to make smaller monthly contributions rather than a larger sum annually.
This year’s plan
As I said, I am trimming $300 a month from my estimated taxes. Since I’m paranoid, I made sure to leave a cushion in taxes paid. Based on my rough calculations, I’ll overpay my federal taxes by around $575; state taxes will be overpaid by about $120.
Of course, if I do sock even more money into retirement this year, it’ll further lower my tax burden and create a bigger refund and perhaps landing me in a similar situation. But with the adjustments I’ve made, the refunds won’t be nearly as large.
Besides, that’s a problem for 2022 Abby.
Anyone else getting a big refund this year? Was it on purpose? And of course, what will you use the money for?