MONEY OBEDIENCE

Yippee, We Got A Tax Refund!

It is this time of the year. April 15^th is approaching fast and we all got to send in our tax returns by then. For many this is a happy time, since there will be a refund. The average refund for the tax year 2009 is $3036 per tax return. That is a nice bit of “change” and comes in handy for many. This time around it may take a little while for the money to be actually refunded since states like New York State might just be delaying the payments but the money is still going to come.

One could argue that we should not leave that much money with the government but at today’s interest rates we are not giving up much interest income during the year anyway. If you put $3036 into a savings account that yields 1.2% yearly for 8 months, you would get $24.30, which is the interest income you don’t get by keeping the money with the US government, who does not pay you any interest on the loan. Anyway, big deal! $24.30!

I would like to argue that it is better to get a refund than to have to pay additional taxes on April 15^th. From what we know about the average US household’s finances, what do you think the chances are that people have $3036 laying around that they could pay in unpaid taxes on April 15^th just like that? I think the chances are low, which is why it is much better for the average family to play it safe and get a refund than to panic when tax time rolls around and when they owe taxes.

Some bloggers have also argued that you should be careful when you get the refund. Their advice goes something like: “Don’t spend it.” “Pay off debt.” “Add it to your savings account, to your IRA, or to another retirement account.”

They’ve got a point because somehow most of us have some funny feelings about a tax refund. Many of us think that a tax refund is kind of a gift from the government to us. But let me tell you, it is not. This is your own money that the government owes you. The government would not give you a gift like that. Well, not normally – most people got a little gift this year from the government. Who knows what other gifts are in store for us?  But I for one would not bet on any regular gifts from the government.

Still, many of us view tax refund money differently than any kind of other money that we earn. We do a kind of mental accounting (at least that’s what they call it in behavioral finance). We set up different accounts in our heads or even in reality where we put different kinds of money as if one money was different from another kind of money. In our heads we make up a separate “tax refund” account. But the tax refund is really part of the money we earned in the last year. That money should have never been deducted from our hard-earned income in the first place if the books had been done perfectly.

So, when we get this “free” money, we may make plans for it. Sometimes, sure, we spend it on frivolous things. Perhaps we spend “free” money on some things that we would not purchase with the “other” money sitting in the “hard earned money” account. Have you ever done this? But don’t forget, both kinds of money are the same – they come from the same source: our labor. Therefore, I suggest you follow the consensus advice: do not spend the money as if it was some sort of a free gift. It is money that you earned fair and square, by working for it.

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Posted in personal finance