How Big is YOUR Refund?

I’m going to wax philosophical today on the subject of tax refunds.

One of the perennial issues that I discuss with my tax clients is the question, “I have a colleague who makes the same as I do, but he always gets a bigger tax refund.  Why is that?”  I don’t think the American Psychological Association has ever identified a malady known as “Refund Envy,” but I could certainly give them some excellent clinical examples.

Let’s start with the non-philosophical answer to that question.  A number of factors determine the size of your annual tax refund, and it’s certainly possible (even likely) that even though Taxpayer Smith and Taxpayer Jones have the same income, their refunds could be miles apart.  Smith might have an elderly mother for whom he provides support – and thus claims as a dependent.  Jones might have deductible interest from a second mortgage or be writing off prior year stock losses.

I’ll get into the blood gore and guts of managing your refund (specifically how to strategically use your Form W-4 Withholding Allowances Certificate) in a future post, but for now let’s talk about the relative merits of big tax refunds.

Nobody likes getting stuck with a big tax liability at the end of the year.  But at the same time, you shouldn’t necessarily assume that a big tax refund is a fate to be envied.  Remember this if you remember nothing else:  Your tax refund is not a gift and it’s not a prize – it’s your money.  Getting a refund simply means that the government has been holding on to your money all year, and now it’s time for them to return it.

Without paying any interest.

Think about a refund in this way, and suddenly that big, fat check doesn’t seem nearly as appealing.  A tax refund basically amounts to your giving the federal government an interest-free, short-term loan.  When you starting thinking about what that big, fat check could have accomplished as a big, fat annual contribution to your IRA, it’s enough to make you a little ill. 

But there are people who insist that avoiding any complications with the Internal Revenue Service for underpayment of their taxes is worth missing out on that additional income.  The thing is, the penalty for a slight underpayment of your taxes is not particularly steep, and there are multiple conditions under which the IRS will waive the penalty altogether.  Over time, some people forfeit thousands in addition income to avoid a one-time penalty of less than a hundred dollars.

Now all of this is not to suggest that, for some people, a large refund is the worst thing that could happen.  Some taxpayers know themselves well enough to understand that if they had an extra $200 per month in their paycheck, they would spend it all in no time flat.  And using an IRA or 401(k) contribution to save for a short-term financial goal like the down payment on a new car would be a bad idea – the tax and penalties for early distributions from an IRA would wipe out a good chunk of your nest egg.

Since very few banks offer Vacation Club or Christmas Club accounts (they went the way of a shiny toaster with a new checking account), and those that do offer interest rates of an astounding one-fifth of one percent, you could certainly argue that using your annual tax refund as an enforced savings plan is not the worst idea in the world.  It actually makes sense for the right person.

The point here is that your tax refund is your money, and you should use it in a way that’s beneficial and comfortable for you as an individual.  So what I’m really trying to say here is size doesn’t matter.

That last sentence was your reward for reading this blog all the way to the end!  Have a great day!

Welcome to My Blog!

We're going to start this blog with a little personal finance.  Already own a home?  Great!  Managed to keep your home during the recent economic disaster?  Well Done!  Pass this along to someone who is testing the home-buying waters.

How To Lose Money On Your First Home

First of all, congratulations on your decision.  With interest rates still very favorable and the existing home market still struggling, you really couldn’t find a better time to buy your first home.  The potential bargains to be had out there are the best that we’ve seen in decades and (one hopes) will be the best we’re likely to see again at any time in the future.

That being said, you can still lose a bundle on your first home if you follow just a few simple steps.

Fall In Love.  Your first home is going to be your first place that you can call your own -- whether you’re a single person or half of a couple.  It’s where you’ll get that dog your parents never allowed you to have and where you’ll bring your first child home from the hospital for the first time.  You’re going to make wonderful memories in your first home – so remember that it doesn’t make much difference which home you’re in.

People in love do foolish things, not least of which is to overlook the obvious faults in the object of their affections to the point that their friends wonder, “What does she see in him?”  The same goes for a first house – don’t fall in love with a certain architectural style to the point that you’re willing to overlook an otherwise undesirable neighborhood, and don’t love a great neighborhood so much that you ignore that leaky roof or a cracked foundation. 

Here’s the thing.  The National Association of Realtors says that the average length of home ownership is six years.  That’s because young couples buy a first house, then buy a larger house when they start having children, then move once (or more) during their working years, and then downsize to a smaller house in retirement.  The odds are you’re not going to live in this house forever, so it’s better to buy the house that’s the best deal, even if it’s not the storybook home you always dreamed of.

Don’t Run All The Numbers.  Over the long term, the most costly thing people can neglect to do is account for all the costs of home ownership.  The purchase price – no matter how far the seller came down – is only part of the equation.  Other factors contribute to the total costs, and one of the biggest and most obvious things people overlook is the property tax rate.

In suburban communities, it is possible to have two homes with the same valuation, directly across the street from each other, but Home A has a higher property tax rate because it’s in a different tax district that Home B.  You might wind up paying an extra $300-$400 per year in property taxes because you bought a house that was in the wrong location by only a few yards, and over the course of many years, that could really add up.

On a related matter, if you’re in the market for a condo or in any neighborhood that has a Home Owners Association (HOA), you may be paying monthly HOA fees that could go up to $500 or more depending on the amenities in your development.  And be forewarned that some HOA's can be downright merciless in their demand that you pay your fees – one study showed that more than 75% of HOA’s have initiated litigation against one of their members.

Trust Your Realtor.  No offense to the realtors out there, but the inescapable fact is that realtors typically work for the seller and not for the buyer.  Especially when you’re a first-time homebuyer and particularly if you’re relocating, it can seem like a god-send to have a realtor who can recommend services like home inspectors and mortgage brokers.  But in most cases you’ll be better off either securing these services yourself or, at least, in getting a second opinion.

Many banks won’t write a loan without a home inspection, and it’s important to make sure that the inspection is completed by a person who is trained and licensed to do the job.  Remember that in some states, there are no licensing requirements to be a home inspector, so ask to make sure that the inspector you select has any one of several national certifications.  Don’t trust the person that your realtor “has been using for years for this sort of thing.”  That’s no guarantee that the inspection will be thorough.

When it’s time to finance your new home, chances are your realtor will recommend a local mortgage broker who, again, is someone with whom he or she has a long-standing business relationship.  This is the financial equivalent of a blind date that is going to end in a proposal of marriage (let's face it - not many marriages last thirty years any more).  So don't assume that the rates and closing costs provided by the "dear friend" of your realtor are the best deal in town.  Shop around.  Even a quarter of a percentage point difference in loan rates can translate into thousands in additional interest you'll have to pay over the long haul.

Are there other ways to lose a bundle on real estate?  Sure.  But these will do for starters.