An Interest-Free Savings Account
Jen asks what's wrong with receiving a large tax refund each year. Dave explains that you've loaned money to the government and you didn't get paid any interest.
QUESTION: Jen on Facebook asks what's wrong with receiving a large tax refund each year. Dave explains that you've loaned money to the government and you didn't get paid any interest.
ANSWER: Well, Jen, let's call a large tax refund $4,800. That means that you've loaned the government money, and you didn't get paid any interest and they give it back to you a year later with no interest. If you get a tax refund of $4,800, that means that they've taken out of your check $400 too much each month. You didn't owe that much in taxes. You overpaid on your taxes. But you don't get that money back until you file your tax return. Next March or April or whatever, you start to get your $4,800 back. So you have a savings account being deducted from your check that pays you no interest, and then they close the account and send you the savings with no interest once a year.
Here's the point. What if you had used that $400 a month to pay on a credit card instead of leaving it with them, and that saved you 18% o the credit card? That would have saved you almost $900 in interest during that year if you paid off a $4,800 credit card instead of letting your money be saved with the IRS for free.
If you have a $4,800 refund, we could call that a $900 mistake per year in lost interest saved by paying down a credit card, as an example. It's a pretty big mistake.
Getting a tax refund year- in and year- out because you have too much taxes withheld from your check, thereby earning no interest on that money, would qualify as a stupid thing to do if it costs you about $900 on a $4,800 refund. This is what's wrong with it.