Your Tax Refund: How You Loaned Your Money to the Government at Zero Interest
Most people get a good feeling when they know they’ll be receiving a fat refund on their taxes. But is that really the best financial strategy? If you’re paying off credit cards or a high-interest loan, the answer is probably no. Imagine your tax refund is $3,200, which is about the average amount a U.S. taxpayer got back in 2014. That means you overpaid your taxes by about $267 a month.
If you are carrying a $3,000 balance on your credit cards, you’re probably paying somewhere near 17 percent interest on that amount. If you’re behind in payments, or have made some late payments, you might be paying the penalty rate, which is around 28 percent. By overpaying your taxes, you are loaning your money to the government, interest free, instead of using that money to pay off your credit card balance, so you are losing 17 to 28 percent on that money.
Now, formulas for compound interest are complex and confusing, so let’s simplify our example by imagining the interest is simple. And let’s consider that in January 2015 you overpaid your taxes by $267, but you won’t see your refund until the end of June 2016. The government held your money for 18 months without paying interest, while you paid 18 months of 18 percent interest on that amount: $267 principle x 0.18 annual interest x 1.5 years = $72.09.
That is the amount of money you lost by overpaying your taxes for one month. (It’s actually less than you lost, because with compound interest, you’re paying interest on the interest.) Over the course of the 12 months that you overpaid your taxes, you lost several hundred dollars because you couldn’t use that money to attack your debt.
At DebtStoppers, we often help clients in Atlanta who made poor choices in the management of their debt. Eventually, they got to the point where bankruptcy was the best option for freeing them from the crushing weight of their debt. If you think it’s time to get a fresh start financially, take advantage of a free consultation with one of our experienced bankruptcy attorneys. Call DebtStoppers at 678-673-2142 or contact our office online.