Thursday, March 15, 2007

Tax Refunds as Forced Savings

Yesterday, I wrote post about the inherent evils of tax refunds. To summarize it in a sentence: You're being temporarily cheated out of your own money. I also mentioned the MLB and I intentionally receive a tax refund at the end of the year, even though from a number-only point of view, it's a terrible decision. Today, I'll outline why we still do it.

I'd imagine that everyone who chooses to receive a big tax refund at the end of the year does it for the same reason: trickery. It's a big psychological trick on ourselves.

I've stated before that I'm a fan of forced savings (self-forced, NOT governmental) because it creates a state of artificial scarcity. It's pretty simple: if I put $500 a month into savings automatically, that's $500 less a month I have to spend. This creates a situation where I'm forcing myself to make more prudent decisions about the money I do have available to spend. Since there are things that I must pay for each month (like the mortgage, food, electricity, etc.), the artificial scarcity situation forces me to cut back on unnecessary spending, like a new set of speakers for the living room, or several meals at restaurants, or new pair of motorcycle boots. By cutting back spending on these unnecessary items, we continue to live below our means and put back more and more money towards debt (mortgage, etc.) and towards savings (IRAs, etc.). This is a VERY good thing.

So, by having more money withheld throughout the year from our paychecks, we're implementing another forcing savings, payable in April. Now, this extra bit of money only amounts to about $75 a week, which when paid to us on a weekly basis, is very easy to waste on frivolous, useless things. It's too easy to say "It's only $10...", or "I'll save some money next week..." when you're paid in small amounts. But, when taken away every week, and paid to us at the end of the year, this amounts to a sizable sum of money. And, when MLB receive a big windfall all at once, it's easier for us to say "Wow, we better do something smart with this extra cash!"

Having said all this, it's probably not entirely necessary for MLB and I to do this. We're both rather prudent with our money, and certainly not wasteful. We've developed enough self-discipline to use our money wisely, even when it comes in small chunks.

Even though I'm a big numbers person, I'm not going to argue that you shouldn't get a refund. Do what works for you. If you're disciplined enough to make good use of those smaller amount of money throughout the year, then forgo the refund. But, if it helps you to save or spend more wisely, like it does for MLB and I, get the refund. You just need to realize that you're paying a slight financial penalty for doing it.

I, for one, am okay with that.


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