6 reasons your tax refund is causing you to lose.
It is that time of year again, a time when 40 million American’s will receive an average tax refund of $3,000. Many of the individuals receiving these funds will feel like they have just gotten a reward from the IRS. I used to be in this group until I became educated in personal finance and taxes; this is also when I realized that most people have no idea how taxes work. The IRS doesn’t make it any easier with a complex tax code, progressive tax brackets, tax credits, and tax exemptions.
Ignorance is the primary offender in most cases. For example, most employees simply have no idea what they should be claiming as personal exemptions. As an employer, I have submitted hundreds of withholding forms (W4’s). These forms are usually filled out by individuals without any understanding of what the form is, or how to fill it out. When I inquire where they got the rationale, they say things like “Oh, my mom says always claim 1” or “I’ve always claimed 4”. Neither response is well researched or a precise explanation.
Perception is another cause of large refunds across the masses, tax refunds are “normal”. Additionally, people look at the dollar amount. Most large lump sums will be the largest amount of money an individual has received. They will feel like they’ve done a great job when in reality, they have completely jacked up their cash flow through an entire year!
Here are the 6 reasons your tax refund is causing you to lose:
#1. You will completely blow the opportunity to solve your true problems. We live an instant gratification society and that is the worst environment to have huge sums of money with no plans for its wise use. Many people will blow this money on vacations, wants, and a ton of stuff they don’t need. What they should do is ignore the windfall and beef up their emergency fund. Another great purpose for lump sum deposits could be paying down debt that is holding hostage a sizable cash flow. For example, if you owe $4,000 on your car with $350 monthly payments and your tax return is $3,500, I say find $500 and get rid of the liability!
#2. The refund simply proves you have no idea of how to manage your money. It reveals that there is a lack of financial literacy. Okay just so everyone knows “If you are single with no dependents and have one job, you should claim 2 on your federal exemptions and 1 on your state to get a breakeven/very small refund.” Don’t be one of the 40 million individuals loaning the government money interest-free! Here is a Calculator that will tell you exactly what you should be claiming. It’s from the IRS, I know they scare you, but they know what you owe! Utilize the calculator and stop earning less each paycheck for a tax refund your going to blow.
#3. You just gave the government a $3,000 loan at 0% interest. Wealthy people buy assets, invest, avoid depreciating assets, and don’t like paying interest. Broke people love paying interest, it doesn’t even matter the amount! Close to 1 out of every 4 cars sold in America is financed using subprime loans (predatory loans that target people with poor credit. These loans can have interest rates from 15%to 29%!).
#4. Anticipated refunds act as a buffer to financial problems or rationalizations. Because you anticipate getting a tax refund it will cause you to rationalize poor decisions and use the refund as leverage to smooth your financial situation. We have all had a friend who has used the phrase “Oh I get my refund next month so ….”. For many people, a large tax refund is the closest they’ve ever come to having a sizable emergency fund. The wise thing to do with lump sums is to invest them, save them, or use them to pay off debt. This is not your opportunity to take that vacation you never took, or blow it on a purchase of something that’s out of your income range.
#5. It’s your money and you need it now! Wouldn’t it make the most sense to receive the $3000 per month throughout the year instead of one large lump sum? You would’ve received $250 per month of additional income rather than letting the government hold your money and give it back to you is if you want an award.
#6. You aren’t qualified to handle large sums of money. For some odd reason, most people believe they have the financial literacy to manage large sums of money. If you asked 100 people what to do with $10,000 you get 100 different answers. That’s because we all have circumstances that are different. This is why you should not listen to the advice of peers and you should seek to understand the principles of keeping, increasing, and investing your income. Earl Nightingale once said that we spend more time picking out our clothing than we do planning our success. It is a true statement. Many people wonder why they can’t manage money, and it’s because they’ve never sought to become educated on the subject of money management. I mean you have Google on your cellphone! What’s stopping you from pulling a few videos on YouTube on how to invest in the stock market? What is a mutual fund? What to do with my savings? How to build wealth?
Think your financial knowledge makes the grade? If you are the average American you have received zero financial literacy training for adulthood. Yeah, we learn how to write checks and learn what a bank account is, but where was the training on what to do with large sums of money? What are the best practices to get an apartment? What are the steps to purchase your car? What’s a good interest rate? How to become a homeowner? For all of those things, we depend on our parents to teach us or we listen to all of our peers; only to end up making poor financial decisions that we pay for over several years. Trust me you don’t know enough about money! Wealth is a study that should last a lifetime. The same is true for self-development, happiness, and success.