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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