Why Your Big Tax Refund Is Like Flushing Money Down The Toilet

Every year between January and April it seems everyone gets excited about a big tax refund they expect to receive. This has always baffled me. Is it because I don’t like money? Or maybe it’s because I don’t like to see other people have money. The real reason is because tax refunds are interest free loans made to the government and wouldn’t that money be better off in your pocket?

The average tax refund for 2009 was $3,036, which means tax payers could have had an extra $253 a month if they had proper tax planning. Some people may not think this is a big deal, but let’s look at how much money we would have if we invested that money each month. At the end of each month we invest the $253 into a Roth IRA which will grow tax free. At the end of year one, we’ll have $4,801, or an extra $1,765. If we continue this over a ten year period, you would have $32,421,928! Seriously. Now, if you waited until the end of the year to get your $3,036 tax refund and then invested that at the same rate as above for ten years, you would only have $43,981.

I realize that this scenario might seem ridiculous because our tax situations change and we may not be able to invest all of the money each month for ten or more years. But don’t you want to try? You could be a multimillionaire in just ten years!

I said in the title to this post that a big tax refund is like flushing money down the toilet. The money down the toilet is the interest not being earned. A very simple solution to this is to fill out a new W-4 at work and change the number of allowances. This form has instructions that can walk you through how many allowances you should claim (the more you claim, the less money taken out of your paycheck), but often times you will still get a big refund at the end of the year because the calculations don’t take into account tax credits and deductions. The best bet is to consult a tax professional who can help save you the most amount of money by planning for every available credit and deduction.

Here is the other big reason I hear why people love their big refunds: “It’s a forced saving plan which keeps me from spending it on things I don’t need”. As I’ve shown above, it’s not a very good savings plan. And let’s all be honest for a second, how much of our refund goes into savings? We all want that money to go into savings, but most of it ends up in the hands of retailers. This is why I advise people to automatically invest part of their paycheck in their Roth IRA or other savings vehicle. You’ll never see that money and therefore won’t miss it, and if you put it into your Roth, it will grow tax free. I’ll tell you why a Roth IRA is so great in a later post.

So after reading this, I want you to go into work tomorrow and fill out a new W-4 and see if you can’t lower how much tax is taken out of your paycheck. Just compare how many allowances you currently have with what the new W-4 calculates (to find how many allowances you currently have just look at your current paycheck). More importantly, talk to a tax professional who will be able to help lower your yearend tax liability and save you even more.

Being Laid Off: The unthinkable happened

I hear everyday how the economy is getting better and because the GDP has officially reached positive territory we've moved out of the Great Recession. This is great news unless you were just laid off. And I was just laid off.

After years of hard work and putting my wife through lonely late nights and weekends while I bartended, I finally started my accounting career. And in a field that is supposed to be recession proof, there was no worries about me being laid off. So we purchased a house, had central air and a brand new garage door installed, and did a small kitchen remodel.

And then I get laid off for lack of work.

So many thoughts immediately run through my head, but one of the loudest is screaming, "Is my house going to get foreclosed upon after only one mortgage payment!?". After crunching the numbers we will be able to survive.

Only hours after being laid off I started contacting members of my network and received two solid leads. If one of these two positions turns into a job, I might actually turn on a profit on this stretch of unemployment. That's because I was paid all my vacation time as well as severance until the end of the month (vacation time actually covers the first half of July). So if I am lucky enough to start working before then, I'll end up making money (but I'll be happy just to get a job!).

Should my unemployment continue beyond July 15, the financial cutbacks would have to officially begin. Even with the emergency fund we have, I would probably have to put both of my private student loans into forbearance, which means the interest would keep accruing and I would have the option of paying it off each month or capitalizing it. This decision and whether or not to pay it off is a topic for another day.

At this point, I am extremely optimistic of my chances of landing a job before months end so I'll leave you with this thought: No one is safe from cutbacks or layoffs so everyone needs a six month emergency fund in case the unthinkable happens to you. In times of deep recession it should even be 9-12 months. Each month represents total monthly expenses without having to cutback on your accustomed lifestyle. It's never too early to start saving for an emergency, whether unemployment, medical, or natural disaster, that most of us will find ourselves in at some time in our lives.

Public vs. Private School

I live in an area where everyone seems to be alumni of a private high school. As someone who grew up in an area that was just the opposite this is alarming to me. I have always heard that private school was very expensive and I always wondered if children’s’ privatized brains were much smarter. I have a one year old daughter and want her to grow into the brightest, smartest girl possible, so should I be thinking about saving for her education?

Let’s take a look at how private schools match up to public schools.

Cost

The average annual tuition of a private high school education is $8,549 according to the National Center for Education Statistics. This includes both religious and nonsectarian schools. This means a privately funded high school education costs almost $35,000! Now here is the kicker: Since public education is funded primarily through property taxes, you’re also paying a full tuition to public school.

You may be screaming that it’s worth it, that the high cost will equate to a better college which will lead to a better job which will lead to curing cancer! Maybe it will, but since no one has yet to cure cancer, do you really want to sacrifice your financial future to find out?

Public schools educate 88% of the children in America, 2% are home schooled, and I would like to argue that there is no way that the other 10% who attend private school are the only ones growing up to become doctors and lawyers and CEO’s. And let’s remember, public schools are free! The only cost is from taxes which you pay anyways.

Education

You may still be saying private schools are worth it because public education is dismal at best. This may be true in many parts of the country so a closer look at each jurisdiction is needed to make the decision of whether or not to pay for private education. For example, the county where I grew up is one of the wealthiest in the country and yet almost everyone attended public school. This is because the wealth paid for a premier public education system, whereas if you live in a very poor area there is no money to pay for schooling. So assuming all things being equal that private schools do not educate children any better or worse than public schools, we find a catch 22: If my jurisdiction is wealthy and pays for a great schooling system, why pay for private school? And if I live in a poor area then how could I possibly afford a private education? Here is a statistic that reiterates my point: 80% of children who come from families with annual incomes of $100,000 or more attend public schools.

But how about standardized scoring comparing the two schools? Do private schools score better on these tests? On the SAT’s, private school students score an average of 75 points better than public school students. One explanation is that private schools have more access to SAT prep courses. Anyone who has ever taken the SAT’s knows that it isn’t entirely about how smart we are. The other explanation is that private school children are smarter, but I think 75 points falls into the test taking ability category.

External Factors

A few days ago my wife and I were talking about whether or not private school was worth the cost and a couple of factors were mentioned that might outweigh both cost and education: religious aspect and safety (safety from drugs, the “wrong crowds”, violence, etc...). In 2008 81% of private school students attended a religiously-affiliated school. For the extreme cost savings, why can’t parents just send their kids to Sunday school like my parents did?

The other reason why parents wish to send their kids to private school is to protect them from the evils of public school lifestyle. Depending on the area you live, your neighborhoods may be violent, drug laden black holes that suck children away forever into gangs and jail and cemeteries. Of course that is one extreme, but what if that’s where you live? I bet those public schools aren’t very successful. If I lived there I would sacrifice everything to send my child to a private school to get away and have a chance at a better life. So ultimately there is much more to think about than just dollar cost and quality of education.

Financial Gains

At this point, assume for a second that the decision is based solely on dollar cost. As I mentioned earlier, the average cost of a private school is $8,549 per year, or almost $35,000 for high school. Now what if you took that $8,549 and invested it each year earning an average 8% return? After four years you would have close to $50,000. That’s an impressive gain in such a short amount of time. For most of us that would equal a one year emergency fund which, over the past couple of years, we’ve all learned how important it is to have given current economic conditions. Now think about how much it would cost to send your child to 12 years of private school vs. how much you would have if you invested it. The numbers are staggering.

Conclusion

As I said before, there are many factors to consider when deciding on public vs. private schooling such as cost, quality of education, and religious aspect. Some will be more important than others but at the end of the day, I urge everyone to also think about what is financially sound for the family and consider the consequences of paying such a high price for education.

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