“But one must take pride in paying up every April 15. Look at it this way: If you don’t spend your dollars on the IRS, you’d probably just squander it on foolish things, like food, rent.”
I recently was driving and listening to the radio, when an ad came on which almost made me run off the road. It was a Visa ad, and the pitch was that the best part of paying taxes was getting a tax refund, and to get, and spend the refund faster, it’d be best to put it on a prepaid Visa card. I don’t know at what body temperature blood starts boiling, but I must have been close, because it was certainly simmering.
To me, the best part of paying taxes – sort of like asking which part of the body is least painful to receive a series of pinpricks – is legally avoiding paying for them in the first place! That’s why you should be smart about tax strategies in the first place! Filling out your 1040 or using a software program and hoping at the end of the exercise, you wind up with some sort of huge refund is, to me, an act of throwing your hands up in the air and leaving your financial fortunes to the Internal Revenue Service. Good luck. Sometimes, you’ll get lucky, and sometimes, you won’t.
Worse yet is planning on spending the refund willy nilly on whatever comes to mind at the time the check arrives or the Internal Revenue Service deposits your money in the bank. If you have no plan with your money, then Monkey Brain is happy to come up with a plan for your money. It’ll be like the wild bender the night you turned 21. It’ll be a heck of a lot of fun for about 6 hours, but it’ll leave you with a wicked hangover.
However, the worst possible sin is the one that I see at a ton of these tax preparation places.
Wait. Let me stop the story here. I have to ask a question. Someone please enlighten me in the comments at the bottom of this article.
Why do people think that someone dressed like the Statue of Liberty spinning some sign in front of the lowest possible cheap rent strip mall hole in the wall is going to get them some massive tax refund that a trained CPA couldn’t find?
OK. Rant over. Carry on.
With terms like Rapid Refund or Refund Anticipation Loan (RAL), these tax refund cashing services make it seem like a convenience to get your refund earlier than the Internal Revenue Service will give it to you. Instead, they’re fleecing you. It’s the same with a Visa prepaid card deposit service that a lot of payday loan wannabes are offering. They’ll charge you an origination fee, then servicing fees, and monthly fees, and pretty soon, your refund is dust.
If you’re counting on your refund as part of your budget, then you have some serious budgeting problems. You should either be budgeting in the first place, or you should be looking for extra sources of income.
Is getting a tax refund the worst of all possible financial sins? No. In the context of this ad, the two transgressions were having the mindset of depending on a refund for your well-being and then compounding the problem by paying a bunch of money to get it just a little early. For 90% of the people who receive a refund, the waiting time is less than three weeks.
No, I am not one of those financial planners who is going to scream ZOMG YOU GOT A REFUND. YOU GAVE THE GOVERNMENT AN INTEREST FREE LOAN! YOU ARE AN IDIOT! Let someone else froth at the mouth about that topic. I’d rather you pay less in taxes in the first place.
Let’s see how much money is being lost by that “free loan” to the government that causes such a lather amongst the financial planning community.
First, the average tax refund in 2010 was approximately $3,000. So, let’s say that you managed to nail your average tax return amount spot on and not send that $3,000 to the government. Assuming a 1% annual interest rate on your money which is compounded at the end of the month and that you manage to deposit that $250 ($3,000 divided equally by 12 months) at the beginning of the month, you’re talking about getting a grand total of…
Drum roll please…
$16.22 in interest. Oh, pre-tax. Given an effective tax rate of 25%, you’re talking about saving $12.17.
ZOMG! THE GOVERNMENT IS MAKING A KILLING OFF OF YOU!
It’d be different if we spent all of that refund check; however, research from the University of Chicago and Harvard shows that taxpayers tend to save their refund checks.
If I compare that behavior to what happens when you suddenly raise your monthly income by $250, unless you’re very disciplined and don’t hop on the hedonic treadmill at all, saving every last cent, you’ll probably wind up satisficing.
MONKEY BRAIN: “MO MONEY, MO BANANAS!”
YOU: “No. This is money we should be saving because we’re not giving the government an interest-free loan.”
MONKEY BRAIN: “WANT BANANAS! WILL TEAR HOUSE APART UNLESS ME GET BANANAS!”
YOU: “OK. Let’s compromise. $100 a month goes to bananas, and $150 a month to saving.”
MONKEY BRAIN: “$150 FOR BANANAS. $100 FOR SAVING. OTHERWISE, ROOF GOING IN 3…2…”
YOU: “OK. OK. OK!!! Deal!”
And, poof, you just increased your cost of living by $1,800 for the sake of not giving the government an interest-free loan to save $12.17. You picked up pennies while dollar bills blew by your face.
Hey, some of you may be made of sterner stuff than I am and be able to save it all. Good for you! You probably don’t need my advice anyway! You can tell the time by looking at your own watch (or computer or cell phone).
For the rest of us, it’s easier to have to say no to temptation one time a year than to have to say it 12 times a year or 24 if you’re paid twice a month.
In fact, I’m going to suggest what some Internet trolls will say is the DUMBEST ADVICE EVAR (yes, Internet trolls have trouble spelling).
If you’re having trouble saving money from month to month and find yourself missing your savings goals…
Decrease the deductions on your W-9
Yes, I suggested you decrease your deductions so that you pay more to Uncle Sam in withholdings. Let me lay out the reasoning for why you might consider this admittedly drastic approach:
- You’re more likely to save the refund. As we explained before in citing the Harvard and University of Chicago study, people tend to save one-time checks rather than spend them. Of course, if you’re someone who relies on that refund as part of your perceived annual income, this won’t apply. You’ll use it to fund that cruise or that new 183” flatscreen that you had to have. The evidence further shows that the more affluent the recipient of such checks is, the more likely that person is to save the money. So, start thinking like rich people. Save your refund!
- The money won’t be somewhere else to tempt you. If you’re like me and use separate accounts for all sorts of irregular spending categories like travel, insurance, or Christmas gifts, then you haven’t really put the money out of reach. It’s simply in another account, and all it takes is one transfer, and BOOM! You’re back in the spending game. If you’re the type who truly needs to have the money out of sight and out of mind, Uncle Sam is a pretty ironclad place to store that money. Once a year, you get the opportunity to tell Uncle Sam that you gave him too much and ask for the money back. There is no two-step transfer process on your mobile phone.
- You can prepare yourself for saving the refund. Before you do your tax refund, write a contract with yourself saying that you’re going to put aside all of your refund into your IRA or emergency fund or whatever you want to do to save it. Sign the contract at the top. That way, once you find out what your refund will be, you already have a plan, and, since you made a contract with yourself, you’re less likely to break that contract.
Yes, this is a pretty drastic action, but it can be a forced savings plan.
Regardless of what you do, don’t get an advance on your refund. Save it! Spend wisely! And, next year, be smarter about paying taxes in the first place!
Am I off my rocker? What do you think? Do you spend or save your refund? Do you do everything you can to avoid an interest-free loan to the government? Tell us about your thoughts in the comments below!