What is one of the best things to look forward to in the first part of the year?

TAX RETURN TIME!!

Everyone loves getting that check from the IRS no matter how big it is. Naturally, the bigger it is the more excited you are when you get it, however, have you considered the fact that the IRS basically holds onto your money for you and doesn’t pay you a dime in return?

You’ve heard it said by a lot of financial folks that getting a tax refund is the equivalent of giving the IRS an interest free loan.

Let’s consider this: Getting a tax refund is like putting your money in a 1 year Certificate of Deposit every year with no return on your investment. None. Zero. Zilch. Zero in a foreign language.

I was researching this a little bit and I came across an interesting blog post on Mint.com on this very topic. The first few sentences sounded like the writer was going to say the same thing about loaning the IRS money interest free. Then the gets in to reasons why it is better to actual get a refund!

Um…ok…?

My thoughts exactly.

The couple of reasons this person gives for it being better to get a refund follow.

  • Paying the right amount of tax is too hard. Maybe for some people it is but for the average american there is a little site called paycheckcity.com that makes it really easy to figure out what you are paying in taxes per check. For example, my wife and I received a good sized refund this year. We deliberately kept claiming 0 on both our W4s for last year even though we had 2 children and a house just to see where we were at. Then what we did was we took our refund and divided it by 26 paychecks a year. That was the amount per check that we were overpaying on taxes. I went to PayCheckCity and figured out my check amount claiming 1, 2, and then 3. I noticed claiming 3 would be a little under what we were overpaying a paycheck. I filled out a new W4 for my job and sent it in. Total time that took? About 30 minutes. Not bad and it gives me an extra $80 a paycheck.
  • An interest-free loan isn’t so bad when the alternative is interest-free savings. Apparently this person forgot that a lot of Americans have credit card debt. It is great that you can pay off a credit card or two when your tax refund appears in your bank account (remember when we received paper checks?) but what if by having that extra money per month you could have paid off one or both of those interest-bearing credit cards in 6-8 months? That would have saved you 4 months of interest at least. It may not be a good investment to put money in a bank account making less than 1% per year, but I would call paying off a credit card charging 12% interest a great investment. That is 12% more money than you would have had!

There is some evidence to support that Americans at least want to use their tax refunds for good. Back in 2010 Bankrate did a survey asking Americans how they would use their coming refunds. Of all surveyed 58% were going to save it, invest it, or use it to pay down their debt. I have yet to find a survey that actually says what Americans did with their refund instead of what they plan to do with it. There is a big difference. Since my wife and I get paid 3 times this month instead of 2, I wanted to put away $1900 in savings this last paycheck. How much did I put away? $1400. Not everyone is able to do what they plan to do with the money they get.

So let’s go through again some steps to take to get that refund close to zero but also taking care to not owe Mr. Taxman anything.

  1. Take how much your refund was and divide it by 26 (if you get paid bi-monthly or monthly than this number would be 24 or 12 respectively). This gives you the amount you are overpaying per check. For example, if your refund was $3000, at 26 checks a year you are overpaying just over $115 per check. 
  2. Head on over to paycheckcity.com and put in your state and salary information. They have hourly and salary calculators. Change the number you claim for your federal taxes to 1 on the paycheck calculator. See how much extra you have per check and then repeat. This time enter 2 for federal. See where that gets you. Using our $115 overpayment per check, stop when the number you enter for federal gives you more than that amount extra per check. For instance, if you put in 4 and it gives you $138 extra per check you should go back and claim 3 (which, for example, might give you $104 extra per check).
  3. Fill out a new W4 at work claiming what you need to claim in order for you to come close but not exceed having that extra $115 per check.

Pretty simple, eh?

Now, my wife and I may have to adjust again after this year. Last year we had our second child at the very end which allowed us to get that tax credit for the whole year. However, we could not itemize. Since we bought our house in August of last year the amount of interest and taxes we paid did not allow us to exceed the normal deduction our government allows everyone to take. So we just took the standard deduction. This year we will have paid plenty of interest and taxes for our home so it will matter. We may end up getting a refund next year as well even though we were able to add deductions this year. If so, we will adjust again!

Do you have a different way of viewing tax returns? Do you honestly use your returns every year to better your financial future? And could you do something different with the money if you had it every two weeks instead of once a year? Comment and let me know your thoughts!

Cheers!

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