Why a Tax Refund Is Not Something to Celebrate
NEW YORK ( MainStreet) Granted, U.S. citizens are mandated by law to give the IRS a portion of their earnings, but what portion seems to be irrelevant to some. Whatever amount the human resources chart says to pay in taxes based on the number of a particular employee's dependents, he'll pay it. If the person gets some of it back at the end of the year, he can rejoice. Sound good? Well, some say not at all.
"People need to first realize that receiving a refund is nothing to celebrate," said Gail Cunningham, spokesperson for the National Foundation for Credit Counseling (NFCC). "What other financial agreement would they enter into where they gave someone else the use of their money for a year interest free?"
Despite outcries such as this from financial literacy organizations, the number of people using the no-interest-bearing bank of the IRS is steadily increasing. The total number of federal tax refunds issued for fiscal year 2012 increased to 123.5 million from 122.8 million the previous year.
And apparently this is no coincidence. In a study conducted by NFCC in 2013 that polled tax payers, 58% of respondents said they "intentionally plan to always receive a refund each year." If you are amongst this majority, or part of the 13 % that said they have not given a tax refund any thought, then consider these pros and cons.
Your money could be growing elsewhere. For the 12 to 18 months that you are contributing and awaiting a refund, your money could be reaping the benefits of compounding interest. The average income tax refund in recent years has been in the $3,000 range, or approximately $250 per month, according to NFCC. Receiving that $3,000 in a lump sum at the end of the year has advantages such as being able to buy a big ticket item that you've been eyeing since Black Friday.
But consider the alternatives. If you already have the discipline to put away $250 per month, you could have invested that in the stock market which is estimated to earn 6% to 8% returns. In 2013, you could have made out big as the Dow Jones Industrial Average yielded a whopping 23% return for the year. If you had put that $250 per month into that index fund, you would have earned an additional $338. On the safe side at 6% returns, you would have earned an additional $84.
It's a gateway to savings. Although the payroll deductions are not earning any interest, you are still putting money aside nonetheless. Also, in 2010 the IRS added the option of directing part or all of your refund into a savings bond. The IRS also provides the option of directing your refund into an IRA or a savings account of your choice versus receiving a check. You just need to complete IRS Form 8888.