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The Interest Free Loan You Give the Government Every Year

Every year about 40 Million Americans wait in giddy anticipation for their end-of-year bonus, their income tax refunds.  You might say to yourself, “I’m going to treat myself this year by purchasing something I really want!” But didn’t you do that last year? At this time of year car advertisers start pushing their Tax Season Sales or even, Refund Sales. You could walk away with an unplanned, rapidly depreciating asset… today!

But why do people get so excited about their refunds? Is it because they struggle during the year and finally feel that they can put some money in their pockets? To replicate the feeling of getting a refund try this:

Step 1. Take out a $20.00 bill.

Step 2. Hide it under a book.

Step 3. Forget about the money.

Step 4. Find the money.

Sure you’re excited that you and your money are back together again but nothing has been gained. You might say that nothing was lost either and now you have more money than you anticipated! However, something was lost. You lost the opportunity that having your money, ALL of your money, provides you throughout the year.

By getting a refund you’re essentially saying that you can’t trust yourself with your money, you’d rather someone hold it for you to keep yourself from spending it frivolously. If that’s the case,  you may have a bigger problem to deal with; check out the Valuist article on 15 Money Mistakes.

And the federal government only pays you interest if your refund is paid late. Thus they retain the opportunity to loan, spend or otherwise use your money (and make more money with it) while giving you nothing in return but a psychological sleight of hand.

Personally, I would much rather pay my tax bill at the end of the year than get my own money returned to me like a child’s allowance. In fact, after doing this year after year I find that when I do have to pay it is incredibly easy because I was able to save up and invest more of my money throughout the year. Don’t be average, adjust your withholding and use your money when you need it throughout the year!

The Interest Free Loan You Give the Government Every Year

Source: IRS.gov

How to Adjust Your Withholding

To adjust your withholding all you have to do is fill out a new W-4 with your employer. Each exemption you claim will place more money back into your pocket during each pay period. I’ve found that if you fill in your W-4 honestly you will likely end up about even at the end of the year. If you take too many liberties on your W-4 you will end up with a high tax bill and perhaps even a tax liability, as outlined in our 5 Common Tax Traps and How to Avoid Them article.

If you are self-employed or had a tax bill of over $1,000.00, you are required to manually withhold for yourself and make estimated tax payments throughout the year. There are a lot of issues surrounding estimated tax payments but in brief you must pay either 100% of what your tax bill was in the previous year or 90% of what you expect to owe for this year.

The easiest way to make estimated tax payments is to take you prior year tax bill and divide it by four  and pay your estimated taxes each quarter. For full instructions and worksheets to figure your estimated tax, please see Form 1040ES.

Exceptions to this Strategy

If you are truly unable to save money throughout the year because you can’t keep yourself from spending, a tax refund might be the only time of the year you save any money. In this scenario, it may be best to maximize your refund (while working on your money management skills). If you want to maximize your refund it’s easy just claim “0” on form W-4 and the IRS will withhold the the maximum amount for you.

Do you prefer a bigger refund or more money throughout the year?

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