Myth: Your Tax Return Is Free Money
Can you imagine the following scenario:
You go to the bank with a couple thousand bucks and you decide you’ll open up a certificate of deposit. You ask the teller, “What’s the interest rate for my account?”
“Oh, zero.”
“The interest rate is zero?” you ask again, incredulously.
“Right. Zero. Nada. Null. Nothing. None. El Zippo.”
Then the teller adds, “We keep your money for a year and then we’ll give it back to you.”
If you’re smart, you’ll leave the bank and this surreal scenario in quick order. But, actually, in real life, most people do the very same thing when they treat their tax return as some sort of annual magic windfall. In truth, they just gave a no-interest loan to the government.
But, people who don’t have the discipline to save, use it almost like a Christmas club account. And, when they receive the check, they sort of act like mini-lottery winners; they waste it.
There’s a simple reason how this no-interest loan became a financial tradition.
Most people don’t want to end up owing the government money in one lump sum at the beginning of the new year. And, most people don’t want to trust their interpretation of the rather extensive tax code to figure the right saving amount to cover their tax liabilities.
Some tax experts suggest that you have your employer deduct the minimum amount necessary. Then, take advantage of every legal deduction you may qualify for. Then, each month, set aside an amount in an interest-bearing account that would cover any possible amount you might owe. (One way to do this is to take last year’s return and divide it by 12. Save that amount each month.)
If you can do this, you can be both a good citizen and a smart investor.
This is the third post in a series about financial myths that make you poor. For more information, you might want to read the previous article in this series. It’s called: Myth: Falling Markets Threaten Your Wealth.
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is one of my favorite financial books of all time. It's an allegory about a guy who has a terrible job, and how he overcomes challenges to achieve his dreams.
I’ve bought tax lien certificates for a long time and it’s really safe when you know how the strategies work.There are pitfalls in this strategy just like any other but they’re easily avoided when you research the properties in depth. I love the strategies so much that I started a site talking about it. NoRiskInvestor.comI hope you’ve had an opportunity to pursue these strategies. Wish you the best.
In some concept, you may be right. There are a lot of people who won’t save unless they are made to do so. For them, it initially seems like it is good to get a tax refund. Income tax returns are a psychological mechanism for Americans to start saving. Large wads of cash are an invitation to save; mere nickels and dimes demand to be spent.
Hi Lewis–
Thanks for your comment. I never thought about it that way. Although you could be right–that they were designed to inspire savings–it seems, though, the refund is more likely used for sudden splurges. At least, among folks I know. Yesterday, my friend told me that, minutes after her refund hit her bank account electronically, she used her entire tax refund to put a down payment on a vacation .
I’d like to hear from other readers. How do you use tax refunds? Spend or splurge?
Regarding your friend, its better to splurge with cash than to take the same vacation, use credit cards, overspend and then have to carry a balance…………The way she did it, she was saving without being tempted, and still ended up with something worthwhile without hitting the plastic
Very true!
Or, she could have put that money in a savings account and earned some interest. The interest money might buy her an extra souvenir t-shirt!
Can you donate money to the gov. in return for tax cuts?
I wouldn’t be surprised…