While it’s great to see our bank account take a nice jump, I’m going to explain to you why getting a big tax return is a bad thing.
Your Income Tax Refund is an Interest-Free Loan to the Government
You know that thing you complain the most about on your Facebook wall and Twitter tweets? Yeah, the government. For not liking them so much, you tend to loan them a lot of your hard-earned money. When you get a large refund, it means that the government held on to your money over the past year to do whatever it is they wanted. So what do you get in return for allowing them to use your money? You get your money back. That’s it! It was a free loan.
Let me ask you this: does the government ever give you a free loan?
Furthermore, do you know what happens if you owe the government money for a year? Penalties and interest added on to what you owe. Even a low interest savings account gives you more back. Why loan out your money for nothing?!
Inflation is Important
The Bureau of Labor Statistics defines inflation as,
a process of continuously rising prices, or equivalently, of a continuously falling value of money.
What does this mean? It means that a dollar today will be worth less than a dollar one year from now. There’s a nifty little calculator on the BLS website.
If you enter $1,000 for 2010, you’ll see that this has the same purchasing power as $1,037.49 in 2011. That means that you need $37.49 more in 2011 to buy what you did in 2010.
Look at it another way. If you get a $1,000 tax refund for the previous year, it’s really only worth about $963! Just by letting the government hold your money for a year, you’ve lost $37 in purchasing power. Seems like a great deal, right? BARF!
An Offer You Simply Can’t Refuse
People just never learn. Every year, people drool over that check from the government thinking, “haha! I really got ‘em this year!” I can give you the same deal… if not better.
I hereby offer anybody reading this to send me money. I’ll take cash, checks, money orders or even food stamps. Send me as much as you’d like. And I promise – with my right on the Holy Bible (I love Jesus, by the way) – that I will send it back to you in April… without interest.
Sounds pretty silly when you put it that way, right? But that is absolutely no different than getting a tax return from the IRS.
Some people will argue that refunds are a great way to save money. If they never see the dollars in their checks, of course it’s easier to set money aside for, let’s say, that big screen TV that you’ve been eyeballing for the last six months.
OPEN YOUR EYES, FINANCIAL FOOL!
That’s what payroll savings deductions are designed to do! Increase your retirement plan contributions. Buy savings bonds. Or just put that extra $50 per paycheck into a money-market fund.
Tell you what… I’ll ante up my original deal. Not only will I give you your money back, but I will add a gargantuan 1% to your original contribution. That’s more than money-market funds and CDs are paying. You can’t beat that kind of a deal!
You May Have Tendency to Spend Your Large Tax Return
I hear tons of people say something like, “I can’t wait until I get my tax refund so I can buy…” Getting a fat chunk of change can give someone googly eyes to go spending. If you have the money broken out into small pieces (12, to be exact) in your paycheck rather than one lump sum, you may be less tempted to spend it all on a big purchase.
It’s Your Money!
This is easy — the money is yours. Why wait for it? Folks, if you like lending money out in small pieces just to have it handed back to you in one lump sum at a later point then contact me and I will hold it for you! (I’ll even give you that 1% return.) Seriously. I’d love to have your money growing in my accounts. I’ll give it back to you when I’m finished.
So what do you do now? The goal should be to get as close to zero as possible on your tax return (you don’t owe taxes and the IRS doesn’t owe you a refund). MSN Money has a neat article called Get Next Year’s Tax Refund Now which talks about changing the withholding on your W-4 form so that you can get more in your paycheck rather than pay out more taxes every pay period and get a large refund next year. My wife and I recently changed our W-4 forms and now we are getting an additional $110 per paycheck. That’s $2,640 for the year! Check with a tax professional if you should have any questions.
And please… do not get any more big tax returns. Refunds are bad, bad, bad! Trust me.
Posted in Money Misconceptions
Become an Owner — Not a Loaner
Many people fail financially because of the key concept of becoming an owner, not a loaner. Most people are “loaners.” They invest their money in what they consider to be “safe” investments, usually a local bank or credit union. But here’s what happens.
See I used to think that the bank took my money, put it in a little box labeled “Weirdo’s Savings: DO NOT TOUCH“, open the safe and toss it in the mattress. But that is NOT what they do.
The bank takes your money, pays you the current rate of return, maybe around 1% if you’re lucky, and then loans that money out or invests that money directly into the economy. The bank receives high rates of interest on its investments and is extremely happy to pay you a low interest rate for the use of your money.
As a general rule, what you really have there is a “loaning” account rather than a “savings” account. You are lending money to the bank and they are making a profit off of your money. You have no choice but to reverse the situation if you want to make your money work for you. You must become an “owner,” not a “loaner.”
You must learn to BYPASS THE MIDDLEMAN!
Are You Earning a Guaranteed Loss?
You may feel comfortable with the fact that investments in banks and savings and loans are “guaranteed” against loss by the FDIC. But what you are actually purchasing with that kind of “guarantee” is something you had never counted on — a guaranteed loss!
You invest $10,000 at a 4% rate of return (ROR) in your local bank…
You earn interest for the year: $400
But you pay $100 in taxes on that interest at 25% – $100
So, your net earnings are: $300
Your resulting balance would be: $10,300
…but if inflation is 3%, your buying power would be reduced to: $10,000
You would have actually earned no gain!
The Three-Legged Stool Theory
For years, financials experts used an analogy of a three-legged stool to display the primary sources that provide retirement income. Gone are the days when you can count on a pension from your employer! Only 21% of all private-sector workers have access to a traditional pension plan and the number of employers providing pensions continues to decline every single year.
Don’t even get me started on Social Security! Think SS is secure? Think again. The following is from the 2010 Social Security Statement:
Without changes, by 2037 the Social Security Trust Fund will be exhausted and there will be enough money to pay only about 76 cents for each dollar of scheduled benefits.
It also states…
…but Social Security was never intended to be your only source of income when you retire. You will also need other savings, investments, pension or retirement accounts to make sure you have enough money to live comfortably when you retire.
To put it simply…
It’s up to YOU to fund your retirement!
All together, these three “legs” represented a stable source of income — but not anymore!
Don’t Just Save — Invest!
With the huge problem of low returns in “safe” investments, where can you go to have the opportunity to get the kind of rate of return you need to stay ahead of the savings game?
Answer: Equity investments AKA the stock market
Investing in the market takes you out of the “savings” mode and places you into the “investing” mode. Are stocks guaranteed? No. There is always a potential for loss, as well as gain. But for a greater potential rate of return, many folks are willing to accept a greater degree of risk. Remember what you’ve learned about being an “owner” versus a “loaner.” If you want a “guarantee” on your money, be willing to accept a relatively low return, if any. That return then has the potential to be further lowered by the effects of inflation. In many cases, it may be wise to take on some level of risk in exchange for the potential of significant returns that can build your house of financial security.