In 2021, the average tax refund was $2,827 according to the IRS. Most people end up getting a refund every year, and it's usually a pretty significant amount.
While there are many possible uses for this money, one of the best involves investing for retirement.
In fact, if you invest the lump sum payment the IRS sends you back every single year, you may just end up with a big enough nest egg to almost double the typical retiree income. Here's how.
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Your tax refunds could have a huge impact on your retirement income
If you're like many Americans and you get a tax refund each year over the course of your career, you'll receive a pretty big lump sum payment that's not part of your regular income. Although you're getting your own money back, receiving so much money at once can feel like a windfall. And if you choose to invest this money for retirement each year, the impact can be truly amazing.
To understand what investing your refunds could do for you, consider what would happen if you got the $2,827 the IRS indicated was the average refund in 2021. If you received around that amount every year for 30 years and invested it in assets that earned a 10% average annual return, you'd end up with a whopping $463,873 invested by the time your career was over and you were ready to leave the working world.
Now, if you follow the 4% rule for withdrawing funds, the nest egg build from investing your tax refund could produce about $18,554 in annual income. Considering the average Social Security benefit in 2022 provides $19,884 per year to live on, this means you could come close to doubling the typical take-home income a senior reliant only on Social Security would receive.
Now, you may not get a $2,827 tax refund every single year. But while the money you get from the IRS may be lower during some years, it may be higher during others -- especially when there are special tax credits or deductions available, such as the expanded child tax credit many households were eligible for in 2021.
And of course, if your investments underperform the 10% average annual returns necessary to produce the estimated $463,873 from this strategy, you could also end up with less money. The good news is, if you invest in an S&P 500 ETF over several decades, you stand a good chance of earning this return over time. And if you buy individual stocks, you could potentially do even better.
The bottom line is, investing your tax refund may not be enough by itself to provide you with all the income you need. But it could go a long way toward doing so and could potentially double your income compared with Social Security alone -- especially if you get a good-sized refund, invest it wisely, and invest consistently over the course of your career.
