Do you usually receive an income tax refund from the government every year
after filing your taxes? Does it make you happy?
Should it?
That may seem like a silly question, who doesn’t like to receive a
substantial chunk of money?
That chunk of money comes at a very steep price. The interesting thing
is this: The steep price is invisible to the untrained eye.
We will explore this steep price in the next section.
Why an Income Tax Refund Comes at a
Steep Price
When you receive an income tax refund, how do you feel? Do you already
have the money spent, so to speak? Does it make you want to celebrate?
You won’t want to celebrate anymore, after we discuss the less than
obvious realities of receiving a sizable income tax refund.
There are some obvious factors that you may already be aware of:
1.
The money usually
gets blown on a frivolous purchase, since it is “guilt free money”.
2.
This extra cash
is usually considered to be outside of a budget.
But here is the part that perhaps you have not considered: The
government is keeping some of your money for over a year, without giving
you any interest. If you take a full year, and then add to it another three
and a half months (to get to the following April 15th) you get to
almost sixteen months.
We must divide the first twelve months by two, to be accurate, because
the government doesn’t take out all of our taxes the first day, but it is
spread out throughout the whole year. Then the whole thing is sitting in escrow
for a full three and a half months.
Since all the money for a tax year has already been collected, the
final three and a half months gets counted fully, we don’t need to divide it by
two. So, we are really looking at giving the government a tax-free loan for the
equivalent of nine and a half months.
Did you know that in 2015 the average income tax refund was $3120.00?
That’s a lot of money to be loaning out to the government for free!
What is the cost of loaning that money for free? Well, we certainly
don’t want to use the current interest rates that the banks are paying, since
that is almost zero. In fact, we should use the average interest rate that we
are paying on credit cards.
The average interest rate on credit cards in the U.S., at the time of
this writing, is about 15%. Let’s use that amount, since most of us have credit
card debt. Guess what 15% interest on $3120.00 for nine and a half months would
be? It’s $370.50! That’s the real mathematical cost of floating an interest
free loan to the government for fifteen and a half months.
Now, if there was also an inflation rate of 3%, then the real hit on
your financial world wouldn’t be $370.50; It would be closer to $379.30.
Imagine that amount of money, every year, just flying out your window.
How would you like to apply that extra chunk of cash to your
outstanding credit card debt? You can do it every month.
All you need to do is proactively (PROACT) spend ten minutes, one time
(DOFAT), to fill out and submit a W-4 form to your HR dept.
Simply take your expected income tax return amount and divide it by the
amount of payments that you receive per annum.
For example, if you normally get back about $520.00 per year, and you
are paid bi-weekly, or twenty-six times per year, then you would divide $520.00
by twenty-six. Then you would request, on the W-4, to have your amount withheld
per pay period to be reduced by $20.00.
$520.00 / 26 pay
periods = $20.00 per pay period
Just imagine what a dent an extra $20.00 per pay period could make on
your credit card debt. This is all because you decided to take the reins and
straighten out a fattened withholding amount.
Alternately, every week you could put the $20.00 into your safe. It
builds up so quickly.
There is also the fact that when you fix a situation like this, it does
something good in your brain (DSIYB).
Every time you are paid you will be reminded that you took this extra
step to take control of your resources.
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