In Defense of Tax Refunds
April 03, 2015My friend Sana is awesome. She has the ability to point out a view that I may not have considered before and makes me take a step back a minute and consider other angles. Maybe this blog post can do for others what she has done for me at times.
Every year about this time, I see a plethora of articles about the “right way” to structure your W-4 so that you don’t give the IRS a “tax free loan” during the course of the year. Yes, if you get a refund, it’s true that you overpaid your taxes during the year and earned nothing on that overpayment. It seems like a lot of people in the financial planning/financial advisory/tax businesses have very strong opinions about this subject.
And I’ve talked to people who almost feel guilty that they are getting a refund annually. I have heard “I know it’s not the right way to do it…but I actually get a tax refund every year”. To those people, I want to say that I hear you and I’m sorry that our industry has made you feel like this is a bad thing. It may be exactly the right choice for you.
Here’s an example of someone that I talked to who had just gotten his tax refund. His refund was $3,200 and his CPA and his financial advisor made him feel guilty about his refund. The conversation he and I had went a little bit differently and here’s a little recap of the conversation:
He and his wife make nice incomes, are raising two kids who are in elementary school and they feel like they live paycheck to paycheck. Their advisors tell them that if they would break even at the end of the year rather than get a $3,200 refund, they wouldn’t feel so paycheck to paycheck. I disagree!
They get paid every other week (work for the same company), so there are 26 paychecks per year. $3,200/26 = $123.08. Divided by 2, we get $61.54 per week. For a family of four that has two working parents, two kids in soccer and VERY busy schedules, would they really be better off taking that $61.54/week? My answer was a resounding NO only because I took a few minutes to do the math and ask them this question: “If you had an extra $60/week, how would your life change?” Their answer: “We would probably go to a little bit better caliber of restaurant when we go out to eat.”
If they listened to the advice of their advisors, they would break even during the year and have absolutely nothing to show for it other than a wee bit of enjoyment periodically at a restaurant. Instead, doing it their way, they get a check each year that is their vacation fund. Sure, the money earned $0, but if they broke even, they would put their vacation on a credit card and PAY interest on that balance.
At best, if they had diligently saved every penny of that, they may have earned at a generous 1% rate in a savings account, about $16 in the course of a year. Had they charged their vacation on a 9% interest rate credit card, the interest in 1 month would be about $24. So…exactly HOW was allowing the IRS to have a tax-free loan such a bad thing?
It sounds like a horrible thing in theory. But, last I checked, we don’t live in theory. We live in the real world.
In the real world, if you aren’t completely 100% disciplined and focused and KNOW exactly how much you’d be earning on your IRS loan, then would your situation be any better by breaking even? Would you spend the difference? Would you save it…every single penny? (Really??? Look in the mirror and answer again…honestly this time!)
For those who aren’t disciplined savers, getting a tax refund serves as a great form of forced savings. I know people who use their refund to do a home improvement project, go on vacation, pay for a nice toy (boat slip, exercise equipment, kitchen appliance, etc.) or use it to fund a Roth IRA. Without the refund, these items might very well go unpurchased or become debt. I, for one, am happy for someone when I hear that they have a stated purpose for each tax refund. And, when we figure out how much they’re actually losing in the interest that the government isn’t paying them, they don’t feel as guilty as financial professionals would have them feel.