Your parents are delusional about tax refunds

April 14th, 2011 - 90 Comments

I love tax time because all these kooky weirdos come out of the woodwork — including personal-finance “experts” who don’t know what they’re talking about.

These are the people who will get on TV, or on their online soapbox, and lecture you about taxes. One of their favorite go-tos is this old chestnut:

“If you’re getting a tax refund, you’re giving the government free money!”

What they mean is that you should not be getting a refund, because if you are, the government has been sitting on your money and earning interest for the entire year.

Let me break this down for you.

The average tax refund is about $3,000.

How much interest are you losing if you get a tax refund? $2.50 per month. Yes, you read that right. Two dollars and fifty cents a month. I have that much money in my shoe right now.

What’s more, if you’d had that money, you almost certainly would have spent it.

On the other hand, if you get a tax refund, Americans are more likely to pay off debt and save it.

This is a perfect example of “experts” missing the forest for the trees.

Yes, Mr/Mrs. Expert, mathematically, you should pay the government as little as possible during the year and earn interest on that money for yourself.

However, there are 3 problems with your advice:
1. Your advice is totally unrealistic as Americans spend whatever they have
2. Americans don’t understand withholding, despite your repeated exhortations to “change your withholding!” Perhaps you don’t realize that those words sound like COMPLETE GIBBERISH (why personal-finance education is overrated)
3. Most people would rather get money back than pay it — numbers be damned

So why do these “experts” continue promulgating the same, tired old advice that never changes behavior?

Because they can rap ad nauseum about what we “should” do with our money…but they fail to understand the psychology of what we ACTUALLY do.

I went on PBS’s Nightly Business Report to share this perspective. Check out the video:

Watch the full episode. See more Nightly Business Report.

Note: During filming, the cameraman was like, “Um…do you want to button one more button up?” I tried it and muttered, “This goddamn button adds 10 years” so I removed it. Then the other cameraman made a crack about how many viewer emails they were going to get about me and my shirt. However, I think their average viewer age is in their 60s, and I am not popular w/cougars.

Ok, back to tax returns. The reason for the title of this post (“Your parents are delusional about tax refunds”)?

Because in many households, there is a mom or dad who has some of the kookiest ideas about taxes, sitting there in an old, dusty recliner, spouting off uninformed nonsense about the government and tax rates. Once you’ve heard something enough times — and “getting a tax refund is BAD!” is one of the more innocent ones — you start to believe it.

So send this article to your parents and 3 friends. See what they say. Leave a comment with their responses.

This is just another example of a counter-intuitive money lesson you’ll find on I Will Teach You To Be Rich.

Remember — personal finance is AT LEAST 50% about psychology.

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90 Comments

 

Comments

  1. It can be a little dangerous to have your state owe you money. You may not get it right away, especially if the state is having budget problems. California comes to mind here.

    If you’re counting on the refund arriving at a certain point, this could be a bad thing.

    And do people really do mostly responsible things with their refund? Anecdotally, the people I know blow it.

    This could be a case of six of a dozen, half of another, if they would otherwise blow that portion of their paycheck proportionately when they got paid.

    I just wrote a check for our local tax, due tomorrow. I calculate the 1.4% I owe and put it in my savings account each month. It’s growing a small bit of interest and it’s not being frittered away. And it’s there when I need to pay up.

  2. I mentioned this to my parents on Tuesday at dinner with them, and they were happy to receive a $5000 refund, despite my annoyances at an interest-free loan to the government. I’ve also had a similar discussion with my friends at work, some were happy to get the refund, others share my belief that it is better to owe the government money.

    I agree with your points for the general population. However, my friends and my parents are not like the general population. The people I spoke to carry no credit card debt, save a substantial portion of their income, and own houses they can easily afford (or in my parents’ case, have paid off their house). Thus, we would have saved our $2.50/month. This is really more about general principle of not wanting to give the government money it doesn’t deserve rather than having the extra $30.

    I do agree with your psychology angle. I have a warm feeling about getting money back, despite that it was always mine and I should have had it all along. I’m actively working to break myself of this incorrect gut response.

  3. Ramit;

    This is a great post. I actually use my family’s taxes to increase our savings rate. My husband is an awful saver, and tends to spend most of what is left in his accounts after his half of the bills are paid. I’m the saver, and so am in charge of our investments and our liquid fund. I’ve always had him *increase* his withholding when he’s started new jobs. He forgets he’s paying more of our tax bill (especially since I also do our taxes). When our fat refund comes in February, he gets a little fun money, and I roll the rest into our IRA and house fund. This way, we both pay half the bills, and both save almost the same amount of money over the course of the year, without any arguments.

    :) A.

  4. wrt point 2. If you change the way you frame the benefit, people see the value of changing their withholdings.

    i.e. “Want to get an extra $100 on all your paycheques?” (3k spread out over semi-monthly paycheques)

    The answer tends to be ‘Yes.’

    Personally, I’m happier getting the money up front. (per point 3, I do prefer to get money rather than pay it out — on each paycheque.)

  5. Thanks to all of the available deductions I’ve half a mind to say that it’d be stupid not to get a refund every year, even if your withholding figures are perfect. Just like negotiating your bills over the phone, it’s worth taking a bit of time to look into what expenses you can claim when you file, because the payoff can be significant.

    Speaking of tax myths, it’s amazing how many people will pay for a professional tax preparer when they have simple returns, all because of fear. I’m no professional, but I’ve been helping friends and family out with filing their returns online, and after asking around it’s obvious that these people are definitely not paying for professional advice.

    One would think that because filing online is so quick, convenient, fool-proof and cheap that it would be the logical choice. Wrong! People don’t want their dusty shoebox packed with receipts to remind them of their spending habits, and they’re willing to pay dearly for someone to hold their hand and assuage them of their fears of the Tax Men and the ever-dreaded AUDIT. (gasp!)

    • Hey Freebooter,

      You are so right. I did work for tax preparer for a season. And when you go online, you are accessing the same program I was working from. The only different is online it is about $30, at the service over $100 and way up. I do help my relatives and friends now. ( for free.) The only people that should use a tax service are ones with businesses and odd incomes.

    • I used to do my own taxes and would love to go back to it, but we have money in investments and such all over the place, I do independent contract work, etc. Back a few years, I really enjoyed doing my own taxes – it was interesting and easy enough with all the software around. Enjoyed it a lot more than paying $500 for tax prep! (Admittedly, though, our tax preparer is THE MAN.)

    • People pay for a tax preparer or a CPA because, unlike you, the CPA has generally gone through years of education and training, knows tax law and thoroughly understands how to prepare a tax return. I’m a CPA, and probably 50-60% of the returns we see that were self prepared have errors. Anybody with an ounce of intelligence would know they should go to a tax professional for tax advice, not Joe-Blow neighbor/nephew/friend who says he knows how to use TurboTax and will help them “save money”.

  6. I don’t get it. A tax refund is something you get back when you have paid too much to the government (for whatever reason). How can reciving extra money (often out of the blue) be BAD?

    I’m just waiting for my P60 form (I’m in the UK), then I’ll ship the whole bunch of papers to my accountant. Before I blindly do that, I did my research on HM Revenue and Customs site, and made a neat excel sheet out of it. Comparing that with my last payslip, the government owes me about £800. Saving it!

  7. I think Ramit is hanging out with the wrong cougars….

  8. My sister and mother are happy with their tax returns – they usually accomplish a financial goal (pay off a credit card or save for emergencies) and have fun with the rest. Having it in a lump sum has been helpful.

    I was really happy that my mom creatively used her refund this year to go ahead and finish converting a portion of her place for an apartment. She now collects some extra income every month. Better return than $2.50/month for her.

  9. funny but true . . . to Amy’s point, it’s a great way to force savings through the back-door for someone not so disciplined. personally, I’d rather manage my withholdings and get the least back as possible at year end

  10. You should have shaken the change out of your shoe on-air. Way to tone it down for the old folks!

  11. I agree that it’s better to get the refund than save the little bit of interest. My tax refund arrived just in time to pay for new tires on my car when I needed them most. If I had gotten that money spaced out in my pay checks I would’ve bought a new computer and then would have had to wait when I discovered I needed new tires.

    It’s kind of like finding a $20 bill in your jeans. Yeah, I could’ve got some pennies in interest if I remembered to put that $20 in the bank; but I was damn happy to find that $20!

  12. Ramit,

    You state that most Americans pay off their debt or save their tax returns, do you have any data on this?

    Your very first bullet point states that most Americans spend the money they have. Which I agree with. Most people that I know take their tax returns and spend it on a vacation, a new TV, or something fun. If said person doesn’t pay off credit card debt or save money throughout the whole year, why are they suddenly going to when a windfall comes?

    You know what people do with windfalls.

    I’m with the pundits on this one. It’s not about the interest, that’s nothing, it’s about keeping the money that’s mine and using it responsibly the way I know how to.

  13. Ditto comment #2. The intersection of personal finance and psychology is Ramit’s forte, but he often derides the principles of libertarians because he doesn’t really share them. I’m content to keep my money and the $2.50 (it really should be about five to ten times this amount since any extra funds I get go into index funds) per month. To each their own.

  14. No hard data, but people in debt have probably already bought into the idea of not giving Uncle a tax free loan for the year. Trouble is, since they are already in debt, this indicates they will squander any incremental increase in their paychecks and still be scratching for cash to pay their tax due at the end of the year. People who pad their withholding and receive a healthy refund can do whatever they please with the money…because they are not in a situation where they need the money to pay critical expenses. Use the windfall to buy experiences and memories. These last much longer than TV’s, smartphones, or cars.

  15. I want to second what free booter fox said – I dont know how many parents do their adult children’s taxes, but my anecdata suggests it’s not a small minority. That attitude and acion creates a system of dependency and fosters the lack of understanding that surrounds tax filing.

  16. I received a $2000 return, which means the government gained about $20 of interest on my money. Now, I won’t bullshit. Had that $2000 been spread out over my income for the year, it would have been squandered. Not a doubt in my mind.
    The way I look at this tax thing is that it’s like a saving’s account you can only access once a year. It keeps collecting money and eventually pays out. The government keeps my $20 in interest as a service charge. What an awesome service it is. I paid off a nice chunk of my debt, getting me that much closer to freedom.
    No matter how hard I try, I just can’t fall apart over that $20. The value I got back is just too great. Know what’s a terrible value for your money? Going to the theater for the latest Jennifer Aniston movie. It leeches your time and the only thing it gives back is nausea. And yet… no one seems to care. The government gets a bit of interest on your money and there’s a throwdown. Who cares?!?

    • You received a $2,000 REFUND, not a $2,000 RETURN. The return is the all the forms you fill out, the refund is the money you get back.

      Sorry to be a nag, but this really drives me nuts! At least learn the terminology!

  17. I was going to be a contrarian, but when you’re right you’re right. But I’ll be contrarian about why you’re right.

    The 2.5% is not the issue because if it’s used to pay off debt as you say, then the debt is probably credit cards and it’s probably 20%, so the savings on $3,000 is like $600. You still probably have that much in your shoe right now, but I don’t.

    You’re right because the $3000 is not carried for the whole year. It is $3000 by the end of the year, and only a few hundred per month. However, for lots of people, $3,000 is probably 10% or more of their after-tax income. This is an awesome amount to be saving per month and if they could follow your automation advice, and pump that extra 10% automated money around in debt repayment or investments then it would be a good return.

  18. I’m going to point out two of your comments:

    “Remember — personal finance is AT LEAST 50% about psychology.”

    and

    “3. Most people would rather get money back than pay it — numbers be damned”

    That is absolutely correct, and its the psychological trick that a government can use to make sure they get their “revenues” while you remain docile about it. Cutting a check every year vs having money “skimmed off the top” of your paycheck is going to leave you with completely different positions regarding the ownership of that money.

    Now, the $2.50 in interest you’re earning is a pittance, to be sure, but its more than 0 and in principle, it’s still your money. A better question is how much money you would save in interest on a loan if you could pay MORE to it because you had your entire paycheck, rather than having to wait all year, while your debt bearing accounts are still compounding interest, to pay them off. I bet on a car loan you could save more than that $2.50 in interest if the $3000 you got back in tax refunds at the end of the year were instead available as cash in the month, applied directly to your loan.

    Sorry Ramit. You make a lot of good points on your site. This isn’t one of them.

  19. This article rings true for some people, but not everyone.

    I’ve been aggressively paying off student loan debt over the past 2 years ($43k down. $15k to go…) Every month I stick to a strict budget and pay as much as I possibly can to my shrinking debt-mountain. In my case, the extra [small amount] per month would indeed be put toward my loans, and not be spent on frivolity as the article suggests. In my case, I’d certainly rather have it now than months and months from now. (Either way it would still go to pay debt.)

  20. That’s really a relief to read this. After my son got only a $4 income tax return I wanted to tell him to go change his withholdings so he doesn’t risk owing something next year. But that nagging voice kept saying “don’t loan the government your money”. Thanks for the new perspective.

    • Again, your son got a $4 refund, not a $4 return. Return is the forms, refund is the money you get back.

  21. I love tax refunds. Ramit your math does not add up on my $3000 refund. $2500 of that refund is from tax credits. I wonder how much of the average tax refund is due to credits. Either way that means i only “overpaid $500″. Wait does that make your point even more valid.

    Now to complete my homework and forward this article on.

    • This is a REALLY good point, John. I think the tax credits are definitely something to take into consideration. I forgot about the credits and I think a lot of others may have too when they where shooting down Ramit’s idea. I think the priority should be to maximize your credits and not worry too much or invest too much time in dealing with minimizing the amount of taxes you overpay.

  22. Wanted to add one more thing…

    I showed up at this website broke and deep in debt. Within one year of reading this website and finishing off the book, I’d paid down more than half of my debt ($14,000) and I’d become fiscally responsible. To the point that people were asking me for advice (I directed them all here).
    When I was a financial jackass, I never read the comments. Want to know why? Because it’s the same old and it never worked before. So-and-so is stealing your money, THIS tip will save you more money than THAT tip, win-lose scenarios all around. If your interest is finances, then it’s a jolly good time. If not, it’s confusing and frustrating.
    Considering the success of this site and my personal success, I think Ramit Sethi understands that. He understands that many, many people simply will not invest huge amounts of time or effort to incorporate elaborate schemes to save small amounts of money.

  23. I explained this concept to a coworker earlier this week. He got extremely frustrated and started rambling about how the government just wanted his money and he wasn’t going to give it to them. Over and over he repeated the phrase “It’s the principle of the thing”. I’m learning that this phrase is code for “I know I’m freaking out about something stupid; but I’m not ready to admit it.”

  24. I admit that I normally am like the old farts who says that you’re giving money to the government interest free.

    And while that is true, I think you make some great points, Ramit.

    Let’s say I save/invest 20% of my income. If my income was higher by $250 per month, do you think I’m going to save all of that $250?

    Probably not- I’d probably save about $50 of it, and the other $200 would go to God knows where. Maybe paying off debt, or maybe into my wife’s closet/shoe rack.

    I got a raise in December of about $500 a month. Does that mean I’m saving/investing that much more?

    ….No. Definitely not. I want to enjoy life a little, although I did increase saving to keep about the same % as before.

    Since I’m an above average saver, I know the majority of Americans definitely wouldnt be saving that extra $250 a month that the tax man is collecting. Instead it’d be more stuff in the closet, a new TV, new toys for little Bob and Suzie, etc.

  25. Interesting points, but a bit too harsh. It works for some people, but it’s not the best thing to do.

    In addition, some math considerations…
    If you would have received the money each paycheck then your value to determine AVERAGE balance for the year is more like 1,500 and not 3,000. $3k * 1% int = $30, but really it should be more like $1.5k * 1% = $15 ($16.30 compounded monthly). On the flip side, if you consider when you could get 4-5% interest it could be more like $41.25.

    Lastly, this logic is flawed – “What’s more, if you’d had that money, you almost certainly would have spent it. On the other hand, if you get a tax refund, Americans are more likely to pay off debt and save it.” If you don’t trust people to do the right thing each paycheck how do they suddenly get responsible when they have a huge chunk at once. Don’t most people spend their tax refund?

  26. FWIW my wife and I are accustomed to getting tax refunds. This year, we decided to reduce my tax withholdings and increase the money I put away with my IWTYTBR automatic withdrawals from checking to savings (thanks Ramit!) I was impressed by how much money we had saved up over the months. We had planned to use whatever refund we got plus savings to pay off our last credit card.

    But we wound up owing $3000 in taxes. $1500 of that was from a casino jackpot, so we only missed our usual tax bill by $1500. Yes, we had more than enough savings to cover it, but making that payment left a bitter taste in my mouth. My wife freaked out and immediately increased her withholdings…and convinced me to increase mine. Rationally, I know that we received that money on the front end and had to pay it one way or another, plus we made a little bit in interest. Psychologically, it was a bit demoralizing. It was even harder when my sister-in-law bragged to us about their $4000 tax refund and what they were going to do with the money. We still paid off the rest of our CC debt, so that was a victory in itself. Now, we have the increased level of automatic savings and increased withholdings, and we don’t have any credit card debt. We should be in excellent shape for tax time next year. =)

    • Scott: Paying taxes should feel at least a little painful–tt’ll keep you interested in where all the money is spent. What if you had to write a check every month to cover federal and state taxes, social security, Medicare? You’d constantly be reminded that your hard work goes to cover these things. This is not a political statement, you may feel that those expenses are worthwhile–the point is you should know where your money is going. Automatic tax payments and a tax refund anesthetize us to the how a sizable portion of our income is spent. It’s the same psychological trick as automatic monthly investing–you save without thinking about it and adjust your standard of living according to the money left over.

  27. It’s interesting to see how many people insist that they want to control the money because they’ll spend it better than the government does. And yet, statistically, that’s just not true. It’s just a belief they carry around – that government is bad and spends poorly, whereas they themselves always spend wisely.

    • It’s not that we’ll spend it better than the Government it’s that it’s OUR money not theirs!
      We work for the money we earn and the Government shouldn’t be ALLOWED to take it with out me having it first!

  28. “Remember — personal finance is AT LEAST 50% about psychology.”

    I’ll take the over. :-)

  29. For me, it’s six of one, half a dozen of the other. Any refund I get goes directly into my savings account.

  30. Great post Ramit! I just got a refund and am no longer upset about it.

  31. That logic, passed on by my father-in-law, caused the first financial crisis in our marriage. I was working a dead-end, soul-killing job and had planned to quit, till I started doing the taxes and discovered how much we owed. My husband had misunderstood how withholding worked, had changed it the wrong way, and I had to keep working at that miserable job just to pay the IRS.

    I do our taxes and we get a fairly small refund every year (usually less than $1K). And yes, it goes into our money market account to be used for future expenses.

  32. Of course, Ramit’s reasoning makes sense. But it applies best in an era of super-low interest rates.
    If this is 1981 and savings interest rates are 18 percent, that $3,000 overpayment to Uncle Sam cost you more than $500 in interest.

  33. Ramit, isn’t this one of your ideas, automatic savings? Get a tax refund and then invest it into a high yield saving account. And another positive thing, if you win something ( like Scott, above) you have a cushion so you still don’t pay in.

  34. [...] Your parents are delusional about tax refunds Ramit Sethi. I will teach you to be rich. 14 April 2011. [...]

  35. If you haven’t already read Ramit’s blog post on Timothy Ferriss’ blog (author of 4-hour workweek), I recommend it: http://bit.ly/dIdhZn. I understand Ramit’s logic to be that we fail when we give ourselves too many choices. That’s our irrational selves rationalizing our bad behavior. In other words, if you want to succeed, don’t set yourself up for failure. Put yourself in a good spot to do what will be in your best interests, otherwise you’re irrational self will win all too often.

    Isn’t it interesting how regardless of the amount of money we earn, we magically get to $0 each month? I understand Ramit to be saying it’s easier to do something intelligent with that money when you are faced with that option once rather than than every two weeks when you get a paycheck with an extra $115.

    I’m curious as well, from a psychological standpoint, if saving or paying down a debt in one big chunk rather than the same amount in little tiny chunks is easier and more rewarding.

    • Paying down debt or saving in one big chunk is more rewarding, the small dribs and drabs don’t even make a dent and so you feel like you’re not accomplishing anything. Same reason why people do “cleanses” instead of “diets.” A cleanse is a wam bam thank you mam sorta diet, insta results!

      Actually though, I’d take the extra $250 every month (with average refund of 3k) ….true, the interest argument isn’t relevant right now (really) since interest rates are so low, but it could be at some point when rates rise. But regardless of the forgone interest since it’s a moot point, everyone could use an extra $250 per month in their paycheck right now, right? People miss that point.

  36. I’m one of the people that would probably spend the extra little bit in my paycheck if it wasn’t taken out in taxes. I decided years ago that getting a refund was preferable to having to scrounge for enough to pay my tax bill when it it came time, so I set my withholding to ensure a refund. I figured that I can do more with the whole cookie than I can with crumbs.

  37. From an annual income point of view, a big tax refund doesn’t hurt in terms of lost potential interest. However, from a monthly cashflow point of view, $3,000 overpaid in taxes shorts you $250 every month. That could be better used to automatically fund an IRA or 401(K) each month (resulting in additional tax savings). You’ve pointed out the “forced savings” aspect of a tax refund. There’s another side: “windfall and found money.” From that point of view a person is just as likely to spend the big refund as to save it. I’d recommend people take a realistic look at all there expenses (including taxes) from both an annual and a monthly point of view to come up with a budget executable in both time frames.

  38. I agree that if Americans had to pay taxes at the end of the year they would be out of luck.

    It’s better to get one chunk back every year.

  39. My father has been making that “losing interest” argument since I was a teenager,haha! I have been making the points in this article for almost 20 years! I sent it to him but if it doesn’t arrive on his porch with a stamp on it he will not read it. Thank you for an article that points out the irrelevance and pettiness of such a small amount of money. Personal finance IS about psychology….you hit the nail on the head!

  40. The opposite also has a huge consequence. If you don’t do your calculations carefully and you end up owing the government over $1000 you will be charged a fee. This can easily happen if you do a lot of freelancing and have a lot of investments while having a low withholding at your primary job.

  41. I personally hate all people who whine and complain about the government in general (specific issues not included). Anyone would bitch about the government getting “free money” is a miser and an idiot. Wahhh wahhhh, the institution that gives us roads, school, police, firefighters, libraries, food and drug regulations, working condition standards, a safety net when our multinationals suddenly close up shop and send half of a city into unemployment for a year, is stealing our money! I NEED THOSE BIG MACS THAT I WOULD HAVE BOUGHT WITH THAT $2.50. DON’T TREAD ON ME!!!~ ….STFU, seriously. Americans always want something for nothing. It disgusts me. You get what you pay for, and that includes government. There is a reason our various mortality rates/life expectancies and standards of living are so low for the developed world…

    Anyway, I’ve never actually heard anyone complain about tax refunds before, actually. Even all the conservatives I know love tax return time. My family always does ours as soon as possible, so we have our refund back months before April. We are parents & I’m still a student and have way too much debt, so ours, which was a nice size, though not huge, got split between an emergency account and debt relief and we actually paid our smallest CC off completely, which is a relief.

  42. “Your advice is totally unrealistic as Americans spend whatever they have”

    If your personal finance advice is going to not only presuppose such weakness, but actually attempt to build upon it, you’re just tilting at windmills anyway. So why should anybody pay any attention to it?

  43. Don’t forget that if you miscalculate what you owe the government and end up not paying them enough, you will be penalized after your second consecutive year of owing more than $1000. I’ve made that mistake simply because I am lazy and forgot to change my witholding to take more out. I think it was about $80 that I was charged for this penalty, which of course negates any interest I earned on the 5K the wife and I had to pay.

  44. So, I’m Canadian. First, out with the misconceptions: NO, Canada is not a socialist state and NO, not everything is free here. I work full-time and I also earn extra from a side project of mine. It’s a work in progress but I quadrupled my extra income since January just by reworking some psychological barriers that I noticed thanks to Ramit’s blog. I still consider myself to be at the beginning of my financial UN-learning curve, meaning that I’m still “uncluttering” myself from all the pre-fabricated bullshit I was taught about personal finance during my youth, but I have to say that ONE good thing I did learn back then was to get every penny’s worth from my government tax dollar. Last year, I juiced out a little over 3 G’s in tax returns, took that money and used it to continue building my investment portfolio. At the end of the year, I had made 3 times what I had put in, and the portion I’m paying in interest income is a joke, which brings home the point that I wouldn’t have touched a penny had I left those 3G’s in the government’s pockets.

  45. What is wrong with the government earning interest on my money? The government needs money to run.

    F.Y.I. I love paying taxes

  46. Now why would you say that you love to pay taxes?

  47. Wow, what propaganda

    This author has no idea why the government holds your money or he does and try’s to distract you from that fact by dangling dollar signs in a lump sum in front of the average american reader.

    I only hope no one takes this guys advice b/c it seems to be based upon “how to get rich” if our dollar held it’s value and couldn’t be printed out of thin air.

    then tries to say “it’s only 2.50?” well …add that up…. wish i could hold 2.50 per month of every american’s money and keep the interest for just one year

    there’s not even any mention of the fact the IRS/Federal Reserve are private companies and if there was, i missed it. Because that should be in bold seeming that it’s one of the most misunderstood things about taxes.

    Funny how private banks can get away with taking everyone’s money, make $$ of the interest of holding it, justify taking it in the first place because the government owes them interest because the only way to get federal reserve notes is to borrow them from this private bank with interest.

    See how crazy it sounds?

    Guess lies are easier to explain and swallow….

  48. wow, shouldn’t have read the comments

    some think these taxes pay for roads and schools?

    why would we pay state and local taxes then if our federal government did all this. and it appears people all think that dollar is going to be worth a dollar still in a few months….

    ouch

  49. Why yes sillyamerican, I think we DO see how crazy you sound.

  50. Kathryn: I don’t think anyone would argue that they don’t want an extra $250 tacked onto their paycheck every month but that’s not the point. Ramit is talking about the psychology of a small bump in pay versus a fat check once a year and the differences in how we spend the two. Your comment seems to point to the fact that you would likely spend the money if it was simply rolled into your monthly pay and that is exactly what Ramit is trying to help everyone avoid.

    • oh man there are so many freaking comments on here I could barely find where mine was to respond!
      Yeah, I understood Ramit’s point, that’s why I mentioned that people like cleanses more than diets. And yes, I would definitely spend the $250 extra each month if it was rolled in my paycheck….and I’d spend the 3k if I got it in one lump sum too! I just like having extra money each month, particularly during “wedding season” when those can run up to 1k per wedding to be a bridesmaid in! Maybe I should work on being less popular and then I wouldn’t need to have a revolving bridesmaid fund :)

  51. Thank you so much for recognizing this! I actually have the max withholding take out of my paychecks so that I get a refund at the end of the year. I have had many people tell me exactly what you stated. I’m cheating myself out of money. I’m giving the government free money. The fact is, I know myself and my spending habits. If I have a little extra cash in my pocket, I will spend it. This is why I have my savings and retirement funneled to different accounts before I even get to touch the money in my paycheck. When I get that big refund, I immediately invest it because I can’t bear the thought of wasting it on something frivolous. I know this about myself and act accordingly. I wish other people would understand this. The funny thing is that I am financially better off than most of the people I know who give me this advice! What they should tell people is to just be honest with themselves about their spending habits and act based on their habits instead of trying to completely change their habits overnight.

  52. Not sure if this has been brought up in the comments, but you are sort of cherry picking data points because of the current low interest rates.

    5 years ago when ING was paying 4.5% interest, that free 3,000 dollar loan to the government looks a lot worse.

    If you need a tax return as some sort of forced savings plan, well, I suppose there are worse things in the world. But it’s not a good idea in principle, and it really screws with your budgeting to over-withhold then get a lump sum like that.

  53. There are so many interesting psychological things happening here, its a goldmine.

    I’m a pretty big fan of this blog and frequent readers will notice that what Ramit always mentions people do in broad economic discussions is exactly what is happening here.

    First, notice how people are really diving into the minutiae of macroeconomic theory, going down to the percents and the dollars earned / lost per person per tax bill.

    For instance, look at the “principled” arguments by people refusing to live in the reality of how things are and not “how things should be”. Sure, in a perfect world I wouldn’t have to owe the government (local, state, and federal) any money, period, but we all know thats never going to happen. Seriously, taxes will always be here. It’s not even worth debating. The widespread economic discussion happening in the US about tax rates for certain income levels is just a really loud distraction from the real issues keeping people from doing as well financially as they probably could.

    Namely, and this is a big theme on IWTYTBR: Earning more money. Whether that means getting a better job, getting a side gig, negotiating a higher salary, etc. Or automating your finances to save for a trip, pay down debt, and prepare for expenses down the road.

    The implementation these strategies is fairly easy on paper, but actually getting yourself to do them is not, which is why only a small percentage of people do them and dominate their finances. (Seriously, the simple act of taking all your debts and putting them on a spreadsheet is so easy but how hard is it to get psyched up to gather that information).

    Again, I love macroeconomic debates, but to make noise EVERY year and complain about the government getting an “interest free loan” from us is hilarious at best, sad at worst. IWT readers are pretty smart, motivated people, and I don’t have any shame in saying that sitting around complaining about how it “must be nice” for the government to collect taxes each year is just absurd, get out there and do something positive.

  54. It’s about time somebody stated the obvious. These so-called experts preach that we need to minimize our refunds, but the interest each month is minimal, especially when you consider the amount of interest you would earn in later months like November and December becomes even less significant.

    We as country have a problem saving money, and these tax refunds are more significant to us in size, and thus we use them to paydown debt or save money that we otherwise wouldnt.

  55. Also worth pointing out is that if everyone did as the “experts” suggest, then that interest free money that you’re giving to the government would not exist so the government would find other ways to invent the money – ultimately taking out of your pocket anyways.

    You can’t put a squeeze on the government or it’s spending by controlling your taxes – that’s a joke.

  56. Putting it in perspective with the $2.50 per month really brings it home. And I damned sure could find that much in my shoe… or couch cushion… or cup holder… or somewhere else where change sits for AGES without me noticing. And if I did notice, you’re right, I’d spend it! Thanks for the great post.

    • You need to put that money in your savings account ASAP! You are giving your shoe, or couch cushion, or cup holder a FREE LOAN! You’re missing out of at least 2-3 cents of interest per year!

      Geez, it must be nice to be your shoe and just get free money all the time.

  57. HA! Great thought-provoking post. I agree with at least part of what you’ve said. The fact is, not many Americans care or put enough thought into their finances to ACTUALLY invest or save the money that the government would be refunding them after filing, AND the payoff of a hefty refund is always a perk around April 15th.
    However, is the argument based on a paradigm shift from that of our parents’ generation? (Ie: “Don’t give the government anything.” ‘They’re watching you.”)
    Probably.
    And that’s probably good. It’s probably better to think the best of an agency that works to provide schools, roads, jobs, etc. If your position is that the antiquated advice should be left in the dust, what exactly is your stance otherwise? Just to file as usual and count on that refund? Besides the poignant social commentary, what real, tangible evidence do you have in this position that can put money back in America’s wallet?

  58. This is so alien to what I have always thought but makes perfect sense.
    Thank you.

  59. This sounds like great advice for poor people.

    For me, the opportunity cost of a $3000 loan is a lot more than 1%, it is more like 7% (the average return in the equity market). Thus, the amount of money that the government is taking out of my pocket on a $3000 return is about $280 a year (by your calculation), assuming that the government is holding my entire return for 12 months, which is not the case, but close enough to make a point. So $280 per year invested at 7% would return around $12,000 over the next 20 years of my working life. I owed $5,000 this year. I made $1000 off that money in the market this year before I handed it over to Uncle Sam.

    Remember your audience. I suspect that we are not all idiots that do not have the discipline to save money, we are the people saving and investing money to build wealth.

    You should rename this article, “I Will Teach You How to Waste $12,000 Over 20 Years.”

  60. To the people who keep posting all the numbers to show why Ramit is wrong, please stop. He already knows the numbers. Many of the readers here know the numbers. Even in the video he says, technically it’s the better choice to not get the refund. However, his point, which the number crunchers keep missing, is that while it’s the rational choice to not get a refund, on average (note: on AVERAGE) people will not make the rational choices and perform the rational behaviors required to benefit from not getting the refund. People often opt for the easiest approach. Ramit’s is the easier approach and based on statistics will probably benefit more people.

  61. As a “non-typical American” who doesn’t spend every dime I earn, I can’t agree with your argument. For one, there’s a lot more of us out there who need to make every dime count. My son will receive a $11,000 refund from the feds that I think is a foolish loss of income. To save an equivalent amount just in my credit union will yield him $575 annually; not chump change in my neighborhood. Better yet, invest in one of my tax-deferred mutual funds that pays a 14% annual dividend to gain $1540 that’s rolled back in. With better choices, why would anyone want the feds to use their earned income, without interest, for the year? Time to reexamine withholdings? Show a little discipline?

  62. Before I was done reading this post, the “one of these things doesn’t belong here…” theme music was running through my head.

    The idea of shrugging off a tax overpayment strikes me as going against the grain of IWTYTBR thinking. The folks I hear talk about an interest-free loan to the government aren’t worried about the interest–it’s giving up the use of the money and getting nothing in return for it. If the average return is $3000, that’s 60 bucks a week I could have spent on wine, women and song–and wasted the rest.

    Maybe $60 a week is a rounding error in your world. For the rest of us, that’s $250 a month–a quarter of the way toward the nominal goal of Earn1K.

  63. @Eric

    My point is that if I wanted to read articles for average people, I would go to Yahoo Finance or the like. I thought the point of this website was to teach people to be rich, not that it is better to waste money as opposed to changing fiscal behaviors. I could care less about the psychology of remaining fiscally irresponsible or poor.

    We all have choices to make about what we read every day, and this was another waste of time. But you should rejoice, because the link to this website on my home page is no more and I will no longer waste your time as well.

  64. On principle, I agree with you. I remember my step-mother telling me she didn’t want her raise b/c she’d be in the next tax bracket, therefore her net income would end up being less. And she works in the tax dept. of the government *sigh*. However, I don’t agree with your specific objection to the idea that tax refunds are bad.

    “How much interest are you losing if you get a tax refund? $2.50 per month. Yes, you read that right. Two dollars and fifty cents a month. I have that much money in my shoe right now.”

    $2.50/month is what you’d get out of a savings account, or a really bad investment product (1%ROR). If you invested in a mutual fund, you could get b/w $24-30/month (8%-10%ROR).

    Any financial “expert” worth their salt could set it up so the money was automatically withdrawn from your account, so it’s gone before you miss it (just as if it’s taken right off your paycheck), and growing for you instead of the government. The problem is that most won’t, because there’s more profit in it for them if they give you a lousy investment product instead.

    In my opinion, the *real* reason why the country’s in such a dire financial situation is a result of two major problems:
    1. Almost every company out there wants to keep your money for themselves, and they don’t care if you lose your house, or end up working in fast food in your 60 as a result.
    2. Nobody is actually teaching the general public the rules of the money game. I bet you 90% of people don’t know what the rule of 72 is.

    • Patty, this brings up another psychology problem: everyone believes themselves to be better than average.

      Yes, you *could* get 8-10% return on a better investment. You *could* also lose a substantial portion of it just as easily, in those same investment vehicles.

      But, let’s focus on context. One of the overarching themes of this site is to “focus on big wins.”

      Your best case scenario: save $3000, get a 10% return, make $300 this year.

      Ramit’s advice: do something people will pay you for, make an extra $1000 on the side this month.

      If these were my only two options, I know which game I’m playing.

  65. Since most American’s carry credit card debit the actual opportunity cost is much higher than stated in this video. Say you have a credit card with a $3000 balance and a 20% APR. By not using the extra $250 in your pocket every month to pay off the balance the loss would be $600 (the actually cost would be less than that but you get the point). So waiting to the end of the year when you get your refund to pay off the credit card actually cost you an additional $600, so your balance at the end of the year is $3600.

    Or to put a different spin on it. Imagine you got a $3000 raise at work, however you will not get that raise until one year from now. Most of us would question our employer and ask, “Why do I have to wait a year, I could use the money now.”

    Following the advice of allowing the government to hold on to your money for a year is not a strategy to get rich.

  66. I am wondering how to achieve the same result (a nice refund) as an independent contractor (I’m in sales). To not have a large sum that I owe at the end of this year I am going to have to make a lot more affirmative choices than just increasing my deductions. Should I go with my employer withholding a certain percent of each check, even though the timing of each one is unpredictable? Should I set up a bank account to set aside money? Should I pay the government taxes on a quarterly schedule?

    What is the sweet spot for independent contractors/freelancers??

  67. Thanks for confirming my beliefs! The psychology of money is often overlooked in the finance world; I’ve heard personal finance “expert” after expert espousing this belief of giving the government free money, failing to take into account the spending habits of most people. While it makes financial sense to NOT get a refund, it makes behavioral sense to get one. Does that make sense? Also, by adjusting your taxes to not get a refund, you run the risk of having to pay the government, and we know from psychology studies that humans don’t like things taken away from them.

  68. So $2.50 a month, so $30 a year, times how many tax refunds this year? 70 million? That would be $210,000,000 a year the American public could have in their pockets to spend or invest instead of in the government’s pocket to spend or “cough” invest in “winning the future” for us. I’ve run a business for 14 years, successfully. Should I just overpay my contractors all year long and then invoice them for the ammount they owe me back? Should I go give a big check to my local pizza place because I order from them a lot, and then at the end of the year ask for a refund on any balance I may have? My parents (also successful businesspeople) think writers like you are delusional.

    And not all of us would invest in our bank’s money market to earn $2.50 a month by the way. On a monthly basis I take a few thousand dollars and turn in into tens of thousands of dollars in real estate. There is a time-value to money in the right hands.

  69. Ramit, I totally agree with you. My partner and I paid off our car with our tax refund. I would’ve bought a cup of coffee at Starbucks with the $2.50.

  70. Let’s see if I understand Ramit correctly. I should go ahead and send the government an additional 250$ a month in taxes so that I recieve a 3000$ refund at the end of the year. Is that what he’s saying? Maybe he’s better at selling financial advise than I am. My initial reaction is that I can keep the 250$ and pay bills and or debts on a monthly basis the way a responsible budgeter does. The other thing I could do with the additional 250$ per month is ‘pay myself first’ and put into the asset column somewhere.

    Have I hit the crackpipe too hard on this issue or was Ramit the bogart here because I’ve yet to hear a champion of the IRS based annual savings fund.

  71. Krojex: “Patty, this brings up another psychology problem: everyone believes themselves to be better than average.

    Yes, you *could* get 8-10% return on a better investment. You *could* also lose a substantial portion of it just as easily, in those same investment vehicles.”

    Well, Krojex, all you have to do to be better than the average is to educate yourself, and show a little discipline. As far as the potential for losing a substantial ammount, this is very true; however when it comes to the markets, what goes down must go up (assuming your investments are properly diversified). If you look at the Anex chart you can see the markets rise over long periods. It’d be dumb to put your investments in something that risky if you were close to retirement, but for someone my age (mid 20s), it’s perfect to grow my money. If you put the same ammount of money every month a mutual fund, you will end up with more money in 20 years than if you get something “safe”, when the value goes down (and you’re still investing), it’s like it’s on sale because you’ll get more units/$.

    “But, let’s focus on context. One of the overarching themes of this site is to “focus on big wins.”

    Your best case scenario: save $3000, get a 10% return, make $300 this year.”

    First of all, the “10%” I was referring to is the _average_ a particular fund has had over the last 10yrs, some years it’s been 16%, so 10% is not the “best case senario” (obviously some years it’s has been less). Secondly, if I put $3000, and get a 10% return it’ll double in just over 7 years, if I let it sit there for 20 years my return will be about $18000.

    “Ramit’s advice: do something people will pay you for, make an extra $1000 on the side this month.”

    That’s a good idea too.

    “If these were my only two options, I know which game I’m playing.”"

    Here’s my whole problem, it’s not an either/or type senario. I’d never say that making an extra $1000 is a bad idea, if I make an extra $1000 AND put some money aside for my retirement, then I’m taking care of my finances in the short term and long term.

  72. What if you’re not the average American? I’d like to hear more about the advantages of owing the government money instead of getting a refund since I consider myself slightly more elite than the average American.

  73. I don’t mind getting a tax refund for 2 reasons.
    1. I’d rather get some money back than risk having to scrape up money on short notice because I discovered that I owe taxes.
    2. I live in a democracy, therefore I am the government. I’m not giving THEM a loan; I’m giving it to ME. Maybe all these small interest free loans will keep taxes on the poor from going up so fast.

  74. I understand your impulse, and there’s a fine line to walk between “go with human nature” and “try to improve your nature”, but frankly the way you’ve worded this article needlessly infantilizes people. You could deliver the same message without condescending to people. Why your audience would appreciate that is beyond me. I don’t.

  75. There is however, a significant problem with people getting tax refunds, namely that they tend to spend that refund MULTIPLE TIMES. And this is especially true for those who have a history of getting a certain “stable” amount at refund time; here’s how the *psychology* of it works.

    Late Summer or fall, some major expense occurs (car breakdown, computer dies, etc.) — and the couple spends whatever they might have (via months of austerity) built up as “savings” or “emergency funds” — telling themselves that they WILL replenish that fund… with their Tax Refund. Thus the refund is “spent” once.

    Then at Christmas, money is tight — but they want the kids to have a “good Christmas” experience anyway (which, especially among those in debt means and excess of gifts/toys) — they rationalize that they CAN pile those expenses onto their credit cards, and *so long as they file their taxes early* the refund will come in time to pay off the debt. So before the fiscal year is even over, most have already spent their refund in most cases not just once, but TWICE.

    But, after Christmas is over various things cause them to delay their tax filing– just long enough that those previous expenditures are “forgotten” — so by the time the actual refund is received in April/May, most of it ends up paying off leftover utility bills, paying a delayed mortgage or credit card payment, etc.

    And yet, nearly always the person feels the “need” to go out and BUY something tangible/visible as a “reward” with some significant portion of the refund (and/or some OTHER major expense has occurred subsequently — the washer or drier died, the car needs new tires, etc). So the refund get’s spend an third and often fourth time.

    Refunds, like “big” Christmas bonuses that end up being smaller than expected, and other *anticipated* windfalls tend to create a false DELUSION of “wealth” and get spent IN ADVANCE — the proverbial “counting chickens before the eggs have hatched” is an all too common phenomenon.

    RE: Relative to your “survey” — I would bet that the majority of people answering about the timeline are answering in terms of when they EXPECT to have their cars and/or credit cards paid off. Most likely they will NOT actually be out of debt at that point in time, because that is around the same time that they will trade the car in and take on NEW debt.

    The real pertinent question is whether people know with any degree of ACCURACY the total amount of debt principal they have left to pay off (within say a few % points) — and note I am not referring to “certainty” which (relates to beliefs, however erroneous) but to “accuracy” (which relates to a verification check of their belief versus documented reality) — in my experience only a tiny fraction of the population (probably < 20%) can do this, and I have never found anyone who is deeply in debt that can do so. (They simply do not want to THINK about it, and so they refuse to add the total up, feeling that it would be too disheartening to do so — and they may very well be right, in that if they knew, they would give up).