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Some rules of tax refund fallacy

We always come across this term of ‘tax refund’. It is to be noted that getting a tax refund is not always beneficial to the financial health. Refund in simpler terms means getting some portion of the money back which had been given before while paying tax (paying extra). From the emotional perspective, one may feel that found money is getting back to them and might conjure up ideas on how to use the refunded money. However, when we come across the term from a financial perspective, it means a lost opportunity cost for things which one could have done with the money in the past. Refund is generally initiated when one pays more than necessary.

It is often seen that the tax professionals and consultants sell their value in order to help the person get a tax refund. With proper tax planning, one can pay less money where the question of refund won’t arise. However, if you are looking for a refund, you might be disappointed as you won’t get any money back. But, if you pay less in taxes by proper planning, you are not blocking additional funds which can be utilized for some other purpose as earlier mentioned about opportunity cost lost in the past.

A lot of tax preparer suggests to take out IRA to reduce the income and when the refund comes, the money to pay for IRA is not available and people often generally like to use the money for other purposes. If one is a W2 employee, they can simply go to their employer and can get their earnings changed by a specific dollar amount. The average refund in the year 2016 was $2945 which is an approximation of average $ 245 per month which is quite high whereby no taxpayer received any future retirement benefit or no return.

We have already understood tax refunds from the financial perspective. However, from the behavioural economists, tax refunds means to some tax payers as mental accounting. The money which is coming from refund can be used for various things like vacation, TV or for purchasing any new items. If we keep it aside and think practically if a person took his own contribution and invest it in a net return over a period say 40 years, it would help to pay for say, retirement. One must invest in tax advantaged saving tools in order to plan tax properly and for any further contingency losses.

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