The average tax refund was $2,827 in the 2021 tax year. That's a generous sum of money. And if you use it wisely, it could end up not just helping your finances in the short-term, but also leaving you with a retirement investment account that's much larger than it otherwise would have been.
In fact, you'd be shocked to find out how much the refund you get this year could turn into by the time you're ready to leave the working world.
How your tax refund could boost your retirement account by $50,000
So how can your tax refund add $50,000 to your retirement investment account? It's simple. If you get close to the average refund of $2,827 when you file your 2021 tax returns in 2022, you can invest the money in a safe investment and leave it alone.
If you put $2,827 into an investment that produces 10% average annual returns and leave the money alone for 30 years, by the end of that period of time, your initial $2,827 investment will have turned into $49,329. That's close to $50,000 just from one contribution. And a 10% average annual return is reasonable to expect if you put your money into an S&P 500 ETF, as the S&P 500 financial index has consistently produced this average return over time for long-term investors.
If you're wondering how it's possible to end up with so much money from a single investment, the reason this works is a simple one. Money invested over a long time horizon can grow substantially because each year you earn returns that are reinvested and earn returns of their own.
This is called compound growth. To understand its power, consider a snowball rolling down a hill. With each rotation, it gathers more snow and gets bigger. As that bigger ball keeps on rolling, it gathers more and more snow all on its own without any outside help. Over many, many rotations, what began as a tiny snowball — or a relatively small $2,287 investment — turns into something far bigger.
Now, if you have less time to invest your refund or if your refund is smaller, you'll obviously end up with less since there will be less time for compound growth to work its magic, or you'll be starting with a smaller initial “snowball.” But no matter the size of the refund the IRS sends you, putting it into a solid investment and leaving it alone for as long as possible can be one of the best and easiest ways to end up with a heftier retirement nest egg.
Understanding how a refund can grow so much over time should provide strong incentive to invest the funds for your future if you don't need them for pressing immediate expenses today. When the time comes for you to leave the workforce, the larger nest egg that resulted from your wise investing in 2022 will leave you a lot closer to having the financial security your senior self deserves.
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