Tomorrow is tax day, the last day that you have to get your taxes in at the post office and send them to the IRS. There will be long lines and a good chance that the USPS will stay open late to accomodate people that cannot even make that date.
I mean no offence to any of my readers but if you actually are in the position that you have to participate in this yearly ritual tomorrow, I want you to go somewhere right afterwards and sit down and do a little self examination because, you sir or madam do not have your shit together.
But thats not what this post is about. This post is about one of the dumbest pieces of tax advice I have ever heard. The problem is that I hear it over and over again year after year from very famous people. I hear it on NPR. I see it on CNBC. I read it on Financial Blogs. Worse yet, I actually know two people that acted on this advice and it ended up costing them a lot of money.
The question is whether you should have the government withold the max and owe you money at the end of the year or have the government withold the minimum possible – or even claim exempt – and pay them at the end of the year.
The financial advice is almost always the same: Do not let the government hold on to your money all year because they will earn interest on it. If you hold onto it, you will earn interest on it.
The math is correct. So why do I think this is bad advice? Simple: You won’t follow it.
You will have them withhold the minimum, but during the year 99.999999999% of you will not put that money into a savings account. You will spend it.
Think about it. You know I am right. Do you really want to keep track of your tax witholding yourself? How about the overall feeling at the end of the fiscal year, do you wanna get a nice fat direct deposit in your account or do you really want to write out a check?
Now lets say that you do manage to execute this perfectly and have all the money set aside in April to pay the government: how much interest did you gain for your effort.
Average tax refund is $3000. That makes the interest from a typical savings account about $2.50 a month.
My coffee costs more than that every morning.
So yeah. I usually do not comment directly on tax or investment strategies, but this one is pretty safe: get a check at the end of the year rather than write one. You will feel a whole lot better.
Savings accounts are horrible investments. Super safe investments, even in the worst of times, should be yielding at least 5% a year. Meanwhile if the economy is good, you should be able to squeeze 10% a year easy. And if you’re interested in high risk capital investments, those generally try for a 500% return over a three to five year period (which in this case would be a 100% return).
However the biggest incentive to keep the money is not investment but quality of life. 300/12 is $250 per month. Think of how much $250/month can improve your life? How much nicer of an apartment can you get if you’re willing to pay $250/month more in rent? That’s a car payment. You can have a new car with that kind of money. Or if you can’t afford any car right now, that’s enough to cover insurance and gas every month. $250 per month is dinner out and a movie with a date every week and still having enough money left over for a new video game every month.
Of course the extra money every month is going to make the most difference to people who don’t earn very much to begin with, some of which may need that money just to get by every month. And these same people are the ones who are in the least danger of owing at the end of the year, because at that low of an income bracket you still get money back from the government.
Meanwhile if you’re in a very high tax bracket the government is going to withhold a lot more money, and so you stand to gain quite a bit more by investing that money through out the year instead of letting the government hold on to it.
Fortunately I don’t live in a state that charges income taxes, but letting them withhold can be riskier than playing the stock market with the money. I think it was last year or the year before that California couldn’t pay off its state refunds and everyone who they owed just got an IOU instead.
I am not following you on where you are getting the 250 a month from? Please explain your logic.
I agree about the investments, and thats where I put the money that can sit. The problem is that money for taxes cannot sit that long.
Again, there is a vast difference between what in an idea world people should do and what people will actually do.
Oh, I see. You are taking the $3000 refund and dividing it by 12 months.
The problem with your logic is they are getting that $3000 one way or the other. Your way they will have to keep that separate from the rest of the money that they are saving to pay the tax bill at the end of the year, all year long, never touching it. This is something that historically most people do not wind up doing: they spend it.
My way they get the $3000 at the end of the year, which generally speaking will effect quality of life more than having 250 every month. They just miss out on about $30 of interest.
Would you take a job tracking money throughout the year that paid two dollars and fifty cents a month? I think not.
You will have them withhold the minimum, but during the year 99.999999999% of you will not put that money into a savings account. You will spend it.
Magick is 99.9% discipline. Who doesn’t put money aside each month as a matter of course anyway? Saving one’s taxes is not an impossible feat, investing it wisely isn’t challenging and can be very financially rewarding.
Strange advice you offer here.
Psyche,
I would disagree that magic is 99.9% Discipline, but agree that discipline is needed. But does that mean to work magic we all need to be completely disciplined about everything all the time always? I think not.
No one I know is disciplined about all things. I am very disciplined with money and my ritual practice, but not very disciplined about food intake. Others are disciplined about food and magic, but not money. These are just random examples, but you get the idea.
Savings ones tax money and paying it at the end of the year is not an impossible feat, its just one that:
1. Does not pay enough for the effort involved: $30 a year or so
2. Is not worth the risk of miscalculating and owing the government a big lump sum at the end of the year.
3. Is not worth the temptation to delve into when seeming “emergencies” pop up.
4. Is not worth the the simple painful act of having to write a check out in one large sum to the Government.
This kind of myopic focus is what gives people the idea that they are somehow going to build wealth or get out of debt by making their own laundry detergent, darning their socks, and using only three squares of toilet paper when they shit. These are all worthwhile things to do, but not really for financial reasons unless you are sop flat broke that you cannot afford new socks.
Your way and you invest it only in places where you can get it out by the end of the year for tax time, and make about as much as a small dinner.
My way and you wind up with a lump sum at the end of the year with no effort on your part and which you can then use to open up a meaningful investment account that might actually make you real money.
Its not strange advice at all. Its advice based on what people are very likely to accomplish rather than a utopian vision of what people should do with an infinite amount of discipline, attention, and focus on minutia.
I am with Jason on this one. The return isn’t worth the effort. This year, I calculated my tax refund, paid down my car loan until I thought my refund would cover the balance and simply waited. At the end of the year, it was very easy not to spend a dime of the refund and pay off my car two years early.
I am now free to save half my monthly car payment and spend the rest fixing up my house. Next year, that take refund goes to principal on my house. Maybe I wont’ be a rich investor but having a paid off house is a big deal for me.
This is practical advice, Jason, so those who live in a theoretical world won’t like it. More advice (from a former professional tax preparer, as well as magical worker); there is no reason to be going to the post office tomorrow. File electronically. 1. you get your refund much faster (especially if you use direct deposit). 2. you are less likely to be audited, simply because the IRS assumes no math errors, when the computer programs for electronic filing are utilized.
Yessssssssssssss. Thank you. My mom (an accountant) was just scolding my sister about that piece of advice. Because there are other things to consider too – like the government charging your ass interest and such too.