6 Reasons You Won’t Go to Finance Hell if You’re Getting a Tax Refund This Year

by Darwin on March 9, 2010

tax-refund-hell

There are a select few articles that get republished year in and year out that start to become “gospel” in the personal finance world.  With tax time approaching, you’re going to see several writers and talking heads on television chastise you for the “free loan” you gave the US government this year if you’re receiving a tax refund.  With the average tax refund estimate at around $2700 from the 2009 tax year, that’s roughly $50 per week you could have had in your account instead of on the government’s coffers, right?

Let’s consider the realistic reasons you don’t go to Hell. 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, save for some top online savings rates you can find, how much are you really lending?  Note that inflation is virtually non-existent as well.  Conservatively, by “lending” $2,700 at 1.3%, you forgo a whopping $35 in interest.  I say conservatively because a) 1.3% is the top rate you’ll find virtually anywhere and b) because this assumes a 1 time payment made a full year back.  However, you’re making gradual $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 at least one 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’ve gotta 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 making a final investment into the prior year’s IRA allowance.  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 isn’t guaranteed to those that were used to them in prior years.
  • Many Americans Don’t have an Emergency Fund – for those that 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 that water heater that just busted.  It may be the only time per year that one of these mini-windfalls ever comes around.
  • A Better Strategy for Funds Allocation – 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 4-figure payment coming in once per 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 that is just being finalized now.  Perhaps you’ll want to buy a few thousand dollars of shares in a particular stock which you can’t do with $50 generally (DRIP plans perhaps but they have their drawbacks).  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, 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 those extra $50 each week last year, but now you’ve gotta come up with an unplanned tax payment within a month!

So, there is something to be said for maximizing returns in the long-term, beating inflation and optimizing cash flow.  In the corporate world, cashflow 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, like over $10,000 each year, perhaps it’s worth reconsidering whether that’s too high and 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 national average tax refund estimate at $2,700, perhaps for your given budget, you’re better off each year just leaving it alone.

I’m interested in your thoughts:

For 2009, Did You:                             Lend it         or     Leave it?

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{ 13 comments… read them below or add one }

1 Saving Money Today March 9, 2010 at 9:16 am

I agree with your thinking. Most people are just not disciplined enough to invest that extra money or use it to pay down debt. I for one admit that I would probably just end up spending it so I don’t mind getting a large tax return.

Usually our return is about the national average but this year it’s a bit larger because we have a new baby which means an additional child tax credit. But as soon as it hits our bank account it’s going to pay off my wife’s car so we’ll have no more car payments for the foreseeable future!

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2 ctreit March 9, 2010 at 11:13 am

I think tax refunds have a bad reputation since people don’t think highly of the government, “Washington”, Congress, or anything political. Therefore, we tend to think that leaving money in the government’s hands is a personal finance sacrilege. But it is not really. As you point out, a refund does not cost you that much money in forgone interest income. It is also safer to get a refund than to owe money for most people, since most people don’t have a money laying around with which to satisfy additional tax payments. I’d like to also say that if you get a refund of $10,000 or more, it still is not a big problem. (a) You still don’t give up that much in forgone interest income in actual dollars. (b) If you get such a large refund your income is probably pretty large, too, in which case forgone interest is even less of a problem relative to your income.

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3 Reputo March 9, 2010 at 12:53 pm

So, in reality, you’re losing out on LESS THAN $35 by getting a refund this year.
I had to figure out what exactly it was. For a $2700 refund and a rate of 1.3% means that your refund “cost” you $17.28 (which if you had would have had to pay taxes on so subtract out your marginal tax rate from that). Having tried for several years to get my refund to zero (and failing miserably), I simply can’t keep up with the tax deductions that pop up (make work pay credit and whatever Bush called his credits) and other things (kids being born, property taxes, state taxes, stock sales, ect.) to make it worth my time. Even assuming $17.28 saved, I could make that in 2-3 hours working at Walmart. To eliminate my “$2700″ refund, I would have to make up mock tax returns every quarter and rebalance what is taken out of my paycheck.

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4 Budgeting in the Fun Stuff March 9, 2010 at 1:02 pm

Okay, I get your points. For the majority of society, they are valid, which is sad to me.

BUT, if you have control of your money, it is a dumb idea. Yes, most people wouldn’t save the extra, but I would. In our case, we rather be within $500 either way of what we actually owe every year. In 2007, we owed $200. In 2008, we got back about $100. That works for me since I know where all our dollars go every month (heck, I know where they go in any given day). I’d rather have that extra $50 a month go to Smarty Pig at 2% APR than let someone else keep it for me at a small loss. Why lose that extra $35 a year if you don’t have to?

Also, the same people who need this refund for debt are the ones buying crud with their “wind-fall”. They aren’t investing, paying off debt, or gathering life experiences. They are just ignorantly happy for their “good” luck and waste it anyway. It’s frustrating.

So yes, the majority of society can’t control themselves when it comes to money…for these people, the tax refund issue is the least of their problems. For people reading personal finance blogs, I’m thinking we can aim higher, right? Either they already have control or they want to get some.

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5 Budgeting in the Fun Stuff March 9, 2010 at 1:06 pm

@Reputo
I can see the problem for people with kids or changing lifestyles…trying to play the game would be too time-consuming. For my husband and I (no kids, same jobs, taxes have been the same for 3 years, etc), what we owe rarely changes, so it’s not actually any extra work anymore to figure out how much to get deducted. I will concede that the effort to figure out how much you need to deduct isn’t worth it if it takes up significant time. Good point.

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6 RainyDaySaver March 9, 2010 at 5:34 pm

You’ve hit the nail on the head — interest rates are laughable right now. Perhaps they’ll jump up in the next year or two, but I don’t see myself finding a 5.5% CD again anytime soon. So I’m not too ashamed that the government has been “holding” my money all year.

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7 jim March 9, 2010 at 6:23 pm

I agree that loosing a few bucks a year via lost interest due to a tax refund is not that big of a deal. Some people do seem to freak out about getting a tax refund as if the lost interest was a huge amount. I’d much rather come down losing $10 a year in lost interest by getting a $1000-$2000 refund than end up owing the IRS multiple years and end up getting audited. My tax situation year to year is not very stable so I don’t know what my tax will be exactly until I add everything up at the end of the year. BUT it doesn’t make sense to over pay the IRS too much cause theres better uses for the cash.

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8 Daddy Paul March 9, 2010 at 7:59 pm

I will keep my money a long as I can. As long as I pay 90% and do not have to pay a penalty for under with holding fine with me.

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9 Len Penzo March 9, 2010 at 10:32 pm

I always give the government a free loan in exchange for the forced savings account. The insignificant amount of money I would earn in interest would probably be lost to “leakage” anyway if I reduced my withholding rate and saw a higher paycheck every other week.

I like the guaranteed “windfall” I get each February/March.

Best,

Len
Len Penzo dot Com

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10 Kevin Khachatryan March 10, 2010 at 3:19 pm

Getting a tax refund is a great feeling… especially if you need some quick cash.

The interest really does not matter, $25 on $3000…. assuming your getting that much, chances are you’re not going to be bogged down by earning 1/100ths less.

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11 Four Pillars March 12, 2010 at 10:00 am

I think refunds are more of a legitimate problem if someone is getting big refunds year after year after year. In that case they should try to change something to balance it out a bit.

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12 Joshua December 11, 2010 at 4:40 pm

I disagree completely with everything in your blog. You’re basically teaching financial irresponsibility. You’re right that most Americans would simply spend, and that most don’t have an emergency fund but we should instead be teaching Americans how to use their money properly instead of just forcing them to save in a bad investment vehicle. Give a man a fish and he will eat for a day. Teach a man how to fish and he will eat for a lifetime.

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Darwin Reply:

@Joshua, You give no basis for your disagreement with “everything in my blog”. The yield on a 1 year CD is like 1%. The net present value of that “government loan” is a few bucks. Seriously? Focus your efforts on more value-added efforts than saving a couple bucks from the government – when you may end up owing money come April if you don’t estimate right.

See the forest through the trees.

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Joshua Reply:

@Darwin,

No basis? Even if we use present day money market funds of 1-2%, that’s still certainly better than 0%. Second, CD’s and money markets aren’t the only investment vehicle you should be investing in. How about your both IRA? The stock market since inception has an average of 12% annual growth rate. How about putting that extra money there? Compound interest is your friend. Also, your basis for giving the government a interest-free loan because of an individual being irresponsible is an irresponsible teaching method. We should be teaching to have an emergency fund as that is immediately accessible whereas your money with the IRS is not. Generally people who are irresponsible with there money who need the forced savings through the IRS won’t go fund their emergency fund or pay off debt; they typically use it to go buy more stuff and continue living beyond their means. Last but not least, you’re right that you may owe if you estimate wrong. However, you can simulate your return with any tax software that you use to already file your taxes. Let’s assume that’s even wrong just to take this deeper. As far as I know, there is no penalty for estimating wrong. You’ll just owe what you should have owed to begin with.

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Darwin Reply:

@Joshua, A few things. First off, there’s a difference between “bad advice” and practical advice. I could spout out that you should never spend a dime eating out, you should never tip, you should never buy new clothes and ride your bike everywhere. After all, to do otherwise would be spending money unnecessarily and giving out bad advice, right?

I give out practical advice.

If you’ve been following, you know I’m an avid investor and I like to put money to work. But I stand by my opinion that the regurgitation of these tax articles citing a thousand dollar refund as a great evil – it’s a load.

12% “since inception” – what does that even mean? Which market, when do you consider inception? The more widely cited number is closer to 8% and after an 80% runup from the pivot bottom in March 2009 which 2% GDP growth and 10% unemployment, you actually expect US equities to move 12% per annum from here? Now that’s bad advice. Aside from that, you miss the fact that you’re citing a 12% over a period of over a hundred years, which totally excludes near-term volatility (since we’re talking about a 1 year period). Don’t forget that there was a recent period where US equities lost 50% in that period of time. So, you take massive volatility with that shot at a high single digit return “on average” which is anything but guaranteed over short periods of time.

13 Joshua December 16, 2010 at 10:10 pm

Any good mutual fund will net you, on average, around 12% over the long term. Some years there may be +50% growth and some years there may be losses but as you know, with dollar cost averaging, you stand to gain substantially over the long term.

Tell me, what is to be gained by the IRS possessing your money instead of YOU? Ren if you don’t invest it, wouldn’t it be more practical to have it where you can use it? In your pocket? Forget an irresponsible individual and just think about the practicality that you’re for.

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