It is tax refund season, and people all over America are doing foolish things with their refunds. If you avoid these 3 big mistakes you will be doing fine.
#1 Treating your tax refund like a savings account
We all know somebody who treats their tax refund like a savings account, happily paying in extra taxes throughout the year knowing they will get a big refund at the end of the year. Many of these people have no confidence in their ability to save and think their tax refund is the only way they will ever get their hands on a sizeable chunk of money.
As saving accounts go, tax refunds are lousy. Here are the problems with them:
A. They don’t pay interest. I know this doesn’t seem like a big deal now when savings account rates are less than 1%, but 1% is better than nothing. Also, they won’t be that low forever. Sooner or later interest rates are going to start heading up, and at that point the interest you can earn vs a tax refund will be significant.
B. You can’t get your money until next year. If an emergency pops up you can get the money out of your savings account at any time, but with the tax refund you can’t get to it until next year. Liquidity is important.
C. You may not even be able to get it next year. Every year more and more Americans are the victim of some kind of IRS problem such as identity theft or fake returns being filed in your name. If this happens the IRS will put a freeze on your refund until they can figure out what is going on. It takes the IRS a loooooooooong time to figure out what is going on. You won’t be seeing your money next year after all. Maybe the year after?
#2 Taking a loan from your tax preparer on your refund
A legitimate CPA firm would never take part in this kind of scam, but “tax preparers” such as H&R Block will try to convince you they will give you the money from your refund immediately in exchange for a fee. The problem of course is that the fee they charge is completely unfair.
H&R Block charges $48 to get both your state and federal refunds early with a refund anticipation check. According to the IRS, 9 out of 10 taxpayers get their refund within 21 days of filing. So you are paying a really big fee to get your money early. Let’s say you get a huge refund, say $3,000. Do you know what the effective interest rate is of getting your $3,000 21 days earlier for a fee of $48 is? 28%! That is a lousy, lousy loan they are making you. If you need the money that badly you are better off getting it almost any other way, even a credit card!
#3 Treating your tax refund money different than other money (Blowing it on something stupid)
You work hard for your money, and you are careful with it all year long. You spend only a small amount of your paycheck on things you want vs things you need. But that sensibility goes right out the window when they get their tax refund.
“Wahoo! A big tax refund, I’m going to go buy myself (insert something stupid they don’t need here)!” People will shout when they see their refund finally hit account. Please don’t do this.
What I want you to understand is that money is money. As economists would say, money is fungible, meaning that this money over here is the same as that money over there. If you are careful with your money you work hard for that shows up on your paycheck, you should be just as careful with the money that seemingly just magically appears when you get your refund each year.
I’m not saying you should never get fun stuff, I am saying that getting fun stuff with your tax return money should be explored just as carefully as if you were buying it with paycheck money. Don’t blow it on something fun unless you would have blown your hard earned paycheck money on that same thing. Instead of a shiny new gizmo sensible thing could you have done with that dough? Put it in an emergency fund? Put it into retirement? Use it on some major expense you know you are going to have to make soon?