Getting a refund doesn't mean you're a screwup
6 reasons why you won't go to personal-finance hell if the IRS owes you money.
With tax time approaching, you’re going to see writers and television talking heads chastise you for the “free loan” you gave the U.S. government last year if you’re receiving a tax refund. With the average tax refund estimated at $2,700 or so for the 2009 tax year, that’s roughly $50 per week you could have had in your account instead of in the government’s coffers, right?
Let’s consider the realistic reasons you won’t go to finance hell if you get a tax refund. Not the hypothetical, but the pragmatic.
Interest rates are a joke. This is the primary reason this “loan” issue is bunk. With savings rates paying less than 1% for the most part, except for some top online savings rates you can find, how much are you really lending? Note that inflation is virtually nonexistent as well.
Conservatively, by “lending” $2,700 at 1.3%, you forgo a whopping $35 in interest. I say conservatively because: 1.3% is the top rate you’ll find virtually anywhere, and because this assumes a one-time payment made a full year back. However, you’re making $50 payments throughout an entire year, so that December payment, for instance, earned a couple pennies only.
So, in reality, you’re losing out on less than $35 by getting a refund this year. While you could cite last year’s stock market performance and how much you “could have made,” this isn’t a good proxy. You won’t see massive returns like that again (save for following the next financial crisis) and by that logic, you could lose much more than just lending it to the government in a down year in the future. (Aren’t you happy you loaned the feds money in 2008?)
Most Americans spend what they make -- or more. The tax refund is an autopilot program that virtually guarantees a few thousand dollars coming in at a set time each year. Most people would simply spend the additional $50 each week instead of, say, investing that exact amount. This is reality over theory speaking, but sometimes you have to recognize and accept human behavior over spreadsheets and assumptions.
Tax refunds act as a special savings account. Many people use the annual refund to pay for anything from this summer’s vacation to an investment in an IRA. There are few mini-windfalls in life, but this is an annual one that lends some routine stability to a family budget. Even an annual bonus is no longer guaranteed to those who were used to them in prior years.
Many Americans don’t have an emergency fund. For those who don’t, an annual refund could be used to pay for an unforeseen medical emergency, help with monthly payments following a recent layoff, or pay for the water heater that just busted. It may be the only time this year that a mini-windfall comes around.
A better strategy for funds allocation may result. Many people don’t really have a good plan for what to do with $50 weekly. Perhaps disciplined investors do set up that automatic monthly withdrawal into an investment account, but with a single four-figure payment coming in once a year, there’s plenty of time to plan and think about how to best deploy that cash.
Perhaps with that money, you‘ll want to make a high ROI investment in your house under the “cash for caulkers” plan. Perhaps you’ll want to buy a few thousand dollars of shares in a particular stock that you couldn't buy with $50. Basically, with some time and planning and a one-time payment, many people will put that money to work better than ongoing micropayments weekly.
You may owe money. Nobody ever gets it exactly right when toying with projected deductions and projected income and adjusting dependents. Depending on how your year went, what the latest tax law changes were that you may have missed, and how much you actually made, let’s say you end up owing $500 come April. Is that where you want to be? You had that extra $50 each week last year, but now you’ve got to come up with an unplanned tax payment within a month.
There is something to be said for maximizing returns in the long term, beating inflation and optimizing cash flow. In the corporate world, cash-flow management is gospel and accounts payable/accounts receivable should be optimized to squeeze every penny out of the timing of transactions. However, you’ve also got to realistically assess what the impact would be to having no tax refund vs. a few thousand dollars each year. Ask yourself (since most of you are getting a refund this year): Do you wish you weren’t getting that refund and had the money weekly last year? Or are you relieved and pleased that it’s coming?
If your annual refund is enormous, it’s worth considering whether your money could be put to better use throughout the year. If you carry revolving credit card debt and for whatever reason haven’t bounced that into a 0% balance transfer, perhaps the money could be better utilized paying down debt monthly (with requisite discipline). But if it’s, say, $1,500 or even the estimated national average of $2,700, perhaps for your given budget you’re better off each year just leaving it alone.
I’m interested in your thoughts.
Related reading at Darwin's Finance:
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