Monday, April 13, 2009

Tax refunds more about psychology than finance

On Mondays, we post a question and answer from a reader. Here's an appropriate question for the week in which some of us write a nice big, fat check to the government.
QUESTION: I usually get a large tax refund every year. I use it to pay off debt or buy something I want. Is that a mistake? Am I letting the government borrow my money for free?

ANSWER: I hear stuff like this all the time. Yes, the government is "using" your money all year long and then sending it back to you at tax time. But, really, would you rather save it yourself and write them a big check each April? My experience is that people hate writing that check and most prefer an annual refund. From a pure financial standpoint, the best case scenario is that your withholding taxes match exactly your tax due. That isn't likely to happen, though, and psychology suggests a refund is more palatable than writing a check. After thirty years in the investment business, I've discovered that psychology trumps math for almost everyone!

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