Is It Better to Get a Tax Refund or Owe the IRS?

Ah, the age old question – is it better to get a tax refund or owe the IRS each year when April 15th comes around?

Let’s sit down and see if we can discuss it from both sides of the argument to answer the question: is it better to get a tax refund or owe the IRS.

Taxes – To Give or Receive?

I will start out by saying that for the 2014 tax season, we ended up getting a pretty nice refund – about $1,700!  That’s very nice considering I thought we would actually end up owing money.  For 2013 I think we owed around $1,000, and I just assumed things would be similar this time around.  So, should we make adjustments so that in 2015 we get all of our money up front each month, or is it better to get a fat check come April 15th, 2016?

It’s Better to Get a Tax Refund Argument

I dug up a couple interesting facts on tax refunds from Time magazine online recently.  Time states that about 75% of Americans actually receive a tax refund.  That’s pretty mind blowing and much higher than I would have expected.  The more interesting fact is that for 2013, 58% of Americans say they intentionally planned to receive a refund!  OK… this was a bit surprising to me given that the average refund for 2013 was $2,800 – that’s a lot of money to withhold throughout the year.  Why do folks plan to do this?

My guess is that it all comes down to the savings rate.  Most Americans cannot be trusted to save their own money.  According to TradingEconomics.com, the American savings rate is hovering around 5.5% for the past several months.  That’s not so great…  I think most Americans do not trust themselves to hold onto the money throughout the year and plan to use their taxes (over-payments) as a type of savings account.  Because many folks are living paycheck to paycheck, they simply cannot afford to pay a large tax bill at the end of the year if their income has already been blown on other things.

One other thing to take into account is that because the savings rate is so low in America, most people are actually managing their finances in such a way that they are counting on a refund to channel into their normal spending for big ticket items: a vacation, family computer, down-payment on a car, etc.  If this money were split up and handed out every two weeks, most people would not have the discipline to save it up for these bigger ticket purchases.  Instead, they’d blow it on soft drinks and wasted cable TV packages.

OK – so maybe getting a tax refund isn’t all that bad.

It’s Better to Owe the IRS When it Comes to Taxes

Let’s look at the flip side.  Many would scold folks for giving the government a free loan for a year.  Afterall, why let the government collect the interest instead of getting it for yourself? I think this argument made sense several years ago where the guaranteed rate of return on your money was > 4%.  These days, with the near zero interest rate policy (zirp), I am not so sure this argument holds much water.

Let’s look at a very simple example by using some of the info from above.  Let’s assume that instead of getting a $2,800 return, we elect to receive the $233.33 extra each month.  If we could invest this for free in the market and earn an annualized 7% return, that would be an extra $196 a year that we would make on interest.  I could make a pretty good argument that it would be worth our time to kick Uncle Sam to the curb, take the money, and proceed to run to the nearest exit.  But, it isn’t quite that simple for a number of reasons!

The first reason you wouldn’t actually be making $196 in interest is that you didn’t get the lump sum of $2,800 to invest for a full 12 months.  You only get $233.33 each month, so you’re not getting the full 7% annual return on $2,800!  Check out the table below to see what I mean…

OK – so now we down to $108.47 extra interest each year if you plan to not receive a tax refund… Still probably worth our time.  But wait – there’s more!  We cannot go around investing in the Stock Market for free, can you?  Of course not!  Let’s assume we are charged $5 per transaction (most companies actually charge more) to buy some stock and we choose to buy monthly.  Now our table looks like this:

OK – we still came out $46 ahead.  That’s better than nothing right?  Well, you could always go to investing quarterly instead of monthly, but you would miss out of 3 months of interest each quarter while you tried to minimize your transaction fees.  Here’s what that looks like:

Following this method, we’re able to make about $104 for the year off of interest…

One-hundred Bucks is One-Hundred Bucks, Right?

So, do the folks that say it’s better to owe the IRS on taxes win the argument?  Not so fast!  For the 80%+ of Americans that live paycheck to paycheck, you could easily have your portfolio be down at the time of the year when you need the money.  It isn’t uncommon for the stock market to be down 10%, 20%, or more.  So, if you needed the money for normal annual expenses, you could easily lose quite a hefty sum if you needed to cash it out at an inopportune time.  The Stock Market is really only a good idea if you are planning to keep your investment in the market for > 5 years.  I am sure you’ve heard that before…

Is It Better to Get a Tax Refund or Owe the IRS? – Conclusion

Put all of this together, and what does it all mean?  I would argue that in today’s near zero interest rate environment, it does not really matter which approach you take!  That’s right, do whatever you want  How often do you hear that as financial advice.  You will come out about the same under either scenario for the average person.  Things too keep in mind that could change the advice would be:

• the size of your return (the higher your annual return, the more I would lean towards modifying your withholding to invest it each month).
• the risk free rate of return you could get from a bank in a savings account.  Obviously, if we were back in the 80’s and you could get 10% – 15% return from a savings account, you would want to take the money and give the IRS the middle finger
• If you will actually need to money for expenses in the next five year.  If so, it’s probably a risky idea to invest the money in the stock market.

Is it better to get a tax refund or owe the IRS in today’s low interest environment – you decide!

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As Seen On the Internet

Good morning everyone!  I have some exciting news to share today – drum roll please…

I was recently interviewed on the very prestigious website Mint.com!  They even labeled me a personal finance expert

I feel honored to be associated with such a popular website and personal finance tool.  I am so glad the folks at Mint reached out to me for this great opportunity.  I have to admit, I was a little skeptical at first when I was contacted.  But this is the real deal!

As Seen on the Internet – Give me the Link!

Take the time to go read the quick interview now!  You can find it here: Expert Interview with Derek Chamberlain on Investing for Mint.  In it, I answer six simple questions about personal finance and investing.

Give it a read and let me know what you think!!

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How To Save Money On Shoes

Temperatures are rising, Spring is in the air, new styles are being introduced, and folks are hungry to buy some shoes!

Here are some money saving tips on how to save money on shoes.

How to Save Money On Shoes – When Buying New

1. Don’t buy “one use” shoes – This one should go without saying.  The more types of “niche” shoes that you buy, the more money you will end up spending over the long run.
2. Buy shoes that will fit multiple styles and options – This really goes along with tip #1 above, try not to buy shoes that will just be the style of the year, otherwise you won’t really get more then one year out of them.
3. Buy at the end of the season or into the next – Similar to new car sales, shoes sell on clearance at the end of the season.  The best time to buy sandals?  At the beginning of fall.  The best time to find a great deal on those winter boots?  Check out those Spring sales!
4. Buy shoes on Wednesday – It’s true according to research.  For some crazy reason, shoes seem to be on sale on Wednesdays more than any other day of the week.  Who would have thought?!?
5. Outlet malls – Most of us live within a couple hours drive to an outlet mall.  While it will cost a bit to actually get your butt there, if you can plan in advance to make one or two trips a year to buy your shoes you will save a bunch of money over shopping malls.
6. Don’t buy kids shoes new – Because kid’s feet are constantly growing and they are so rough-and-tough with their shoes, it doesn’t make much financial sense to buy brand new shoes for kids.  See some of the used ideas below before you break the bank on kids shoes.
7. Zappos – Try Zappos for your online shoe purchases.  They have a huge selection, great prices, and awesome customer service.  I have used them multiple times, and I’m a happy customer.  If the shoes don’t fit or you’re unhappy with them, you can return them free of charge!  It’s no wonder it’s such a good company to deal with – they’re owned by Amazon.

How to Save Money On Shoes – When Buying Used

1. Hand-Me-Downs – Why buy new shoes at all in the first place?!?  If you are getting kids shoes, try hand-me-downs from brothers, sisters, cousins, etc.  You’ll save a ton of money and ensure the shoes get used until they fall apart.
2. Goodwill / thrift stores – Not much to say here other than you can find some awesome deals on gently used shoes for 20% of the new price.
3. Ebay – I haven’t bought shoes from Ebay before, but I sure do sell a lot of them on Ebay.  You can generally get good condition used shoes for 50% – 90% off.  Hard to beat that!
4. Yard Sales – This is my personal favorite.  You can usually find 7/10 through 10/10 condition shoes for pennies on the dollar.  Don’t believe me?  Check out these awesome Sketcher shoes I just found last Saturday for only $0.25!!!!!!

How To Save Money On Shoes – My new $0.25 shoes!!!!

How to Save Money On Shoes – Final Thoughts

As you can see, there are tons of ways that you can save money on shoes today!  I’m sure that there’s at least one idea from the “how to save money on shoes” article that you can put in use this year to save yourself a bundle on shoes.  Anyone think they can one-up me and find better shoes for $0.25 or less?  Have I mentioned lately that I love yard sales???

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Should I Downsize My House?

As my MBA classes draw to an end this Spring, our family has one big choice to make.  I’ve been in my current job more than three years, and one potential on the table is to move within my company to just about anywhere in the US.  We don’t necessarily have to move, but it seems like it would be great for my long term career.

One additional bonus of moving is that we’d have the opportunity to downsize our house and save a bunch of money!  Read on below to see just how much you could save – I ask the question “should I downsize my house?”

Should I Downsize My House? – Money Saving Breakdown

• Difficulty (Super Easy/Easy/Medium/Hard/Expert): Hard
• Average Savings per Year ($/year): 7,000
• Time Required (mins): 4800
• Savings for your time ($/hr): 88

Should I Downsize My House? – Why Get Smaller?

What are some of the main benefits if you downsize your house?  There are a ton – here are a couple that I’ve considered in this analysis:

• Interest -The biggest savings I’ll encounter when I downsize my house is the interest that I would normally  pay on my mortgage.  For us, it looks like we’d save more than $200 a month!  Yeah, yeah, this will mean you can deduct less on your taxes, but you’ll still come out way ahead in the end
• Upkeep – This is one that’s kinda a wildcard that most people don’t think about.  Bigger houses generally have more things that can go wrong, and when they do go wrong, it will usually cost you more.  A good rule of thumb is that you should figure to spend/allocate 2% – 3% of the value of the house annually for upkeep.  For us, it seems like we’d save >$2,000 a year by downsizing my house.
• Taxes – Generally, the bigger the house, the more expensive.  It follows that the more expensive the house, the more you’ll pay in taxes each month.  If I downsize my home, we could save more than $70 a month here!
• Heating and Cooling – This is another obvious benefit when you downsize your house.  In my analysis below, I assumed a linear relationship between the square footage of the home and the heating/cooling costs.  While this isn’t entirely accurate, it’s pretty good for estimation purposes.  On the average, I figure we can save another $70 on utilities a month if I downsize my house.
• Home Insurance – This is a smaller factor – I figure downsizing our house will save about $20 a month.
• Lost investment opportunity of Principal payment – The other small difference is all that the extra money you’re putting down as principal with the bigger home you could be putting into investments and gaining interest.  For us, this is pretty small at about $20 a month.

Should I Downsize My House? – Case Study

The example below pretty closely illustrates the change my wife and I are looking to make.   A couple of years ago, we upgraded to a house that is way bigger than what we need.  It seemed like a good idea at the time, we’d saved diligently and had extra money.  In hindsight, I kinda wished we would have invested the money in the stock market (market index funds) vs. a bigger home.

As a result of moving into a bigger home, we’ve been paying an extra ~$7,000 a year for the choice.  If we can make the jump to downsize our house to a 2,000 square foot house (or smaller if I can sell my wife on the idea ), we’ll save about ~$150K over the course of the next 15 years  (assuming an 8% return on the savings)!  That’s enough to send one of our kids to college all expenses paid!!!

Should I Downsize My House? – Final Thoughts

As you can see, there are many monetary benefits for me if I decide to downsize my house.  The same sort of savings would apply to just about anyone.  For me, if I make the change to downsize my house, I’ll save $150,000 over the next 15 years.  If circumstances work out, the savings from this change will be enough to fully fund one of our kids college educations!  Wow!!

What are your thoughts?  Have you ever asked yourself the question: “should I downsize my house?”  Even though this can be a huge, life-altering decision, this is about the biggest way to save money I’ve found so far!

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Do you need short term disability insurance, or is it better to take your chances?

Is it worth it to pay for short term disability insurance?  Or, would you rather risk going without it to save some money each year?

Join me as I dissect the pros and cons of short term disability insurance.  We’ll try to uncover some of the mystery surrounding it.

You may even find a way you could save $500 – $800 a year!

 Money Saving Breakdown – Do You Need Short Term Disability Insurance?

• Difficulty (Super Easy/Easy/Medium/Hard/Expert): Medium
• Average Savings per Year ($/year): 832
• Time Required (mins): 15
  
• Savings for your time ($/hr): 3,328

What is Short Term Disability Insurance?

Short terms disability insurance is a type of insurance that you can buy to protect your income if you become injured or sick.  This will typically pay a percentage of your income for a set number of weeks if you get injured.  This would be above and beyond any type of worker’s compensation, insurance payments if injured in an auto accident, etc.

Who Needs Short Term Disability Insurance?

Who wouldn’t want to get paid if they accidentally get injured?  I’m sure all of us would – there is only one small catch.  Unless you’re one of the lucky ones that has their company provide short term disability insurance, you’ll have to pay for this insurance out of your own pocket!

So, what types of people should ensure they obtain short term disability insurance?  Interestingly, the same people who need life insurance generally need disability insurance, and for the same reasons – to support their financial dependents.  I would recommend you consider short term disability insurance if you fall into one of these categories.  These are:

• Women planning to become pregnant
• People that participate in high risk extracurricular activities.  Examples include outdoor sports, hang gliding, extreme weight-lifting, etc.
• People without a 6-month emergency fund
• People that are already covered with short term disability insurance with a known health issue (could cause missed work for weeks at a time)
• People who travel a lot (long commutes, high amount of work related, etc.)

When doing research on this topic, it’s hard to find straight answers.  This is because almost all of the search results in Google are populated by actual insurance companies!  And they are all trying to sell you a policy!  Hopefully we can take a methodical approach to reason our way through sea of information!

I have a feeling that all of the stats thrown around about the high number of “injuries” are including all those people who normally get pregnant in their lifetime.

Short Term Disability Insurance – Typical Injuries

I found this list of typical short term disability injuries here.  I would guess that most back injuries are from car accidents or home-improvements gone wrong…

• Pregnancy (normal) – 21%
• Injuries (excluding back) – 10%
• Digestive/Intestinal diseases – 7%
• Back injuries – 6%

This seems to validate the pregnancy “injury” that insurance companies are throwing around.  This was an “aha” moment for me because this is the main reason we sought this type of insurance in the first place!

Short Term Disability Insurance – A Simple Calculation

If you don’t fall into one of the categories above, you may want to consider dropping short term disability insurance.  You should weigh the trade-off in how much it’ll cost you vs the risk.  Read on to see how you can calculate your break even injury frequency.

Example To Find Your Break Even Injury Frequency:

In this example we’ll assume:

• a weekly salary of $1,500
• short term disability insurance covers 60% of your salary
• injured/out for 9 weeks total (1 week unpaid plus 8 weeks paid)
• 25% taxes on the payment

1. Your weekly take home pay would then be $1,500 * 60% * 75% = $675
2. Your total payout for the injury would then be $675 * 8 weeks = $5,400
3. Now, find your annual cost of the short term disability insurance.  Let’s assume the cost is  ~$32 every two weeks.  This is $832 annually.
4. Take the $5,400 payout you calculated in step #2 and divide by the $832 cost calculated in step #3.  This will give you the break even number of years you can sustain a serious injury and be out of work for 9 weeks.  $5,400 / $832 = 6.5 Years

Obviously there are a lot of assumptions here.  As long as one doesn’t get seriously sick, pregnant, or injured every 6.5 years it would be better to NOT have the short term disability insurance.  This is because you would save money in the long run by just taking the money and investing it or putting it into an emergency fund.

Short Term Disability Insurance for the Self Employed

Many companies will offer their employees short term disability insurance for free or for a fee payable by the employee.  If you would like to start your own company, then you will have to get short term disability insurance through a private company if you think you should be covered.  If you do own your own company and work from home, there is a below average chance you will get injured all things considered.  For instance, it’s pretty hard to break your leg while you try to run a successful money making blog from home :-).

If you are self employed and run a business where you are out and about during the day (think lawn care, construction, home repair, etc.), then it may be a good idea to consider short term disability insurance for yourself.  A person can still blog from home with a broken leg, but it would probably be pretty difficult to cut lawns with a cast on!

Final Thoughts

I’m lucky in that my company fully covers short term disability insurance for me.  For my wife, we decided years back to obtain short term disability insurance.  This was because we were trying to get pregnant.  After we’ve had kids, we haven’t taken the time to reassess if she actually still needs this type of short term insurance.

Because we don’t plan to have any more kids, I’m not so sure we need it.  We’re not involved in high risk extracurricular activities.  We have a good emergency fund saved up.  We’re both relatively healthy.  And, we don’t travel a lot much.

If the worst were to happen, we’d have to dip into our emergency fund without short term disability insurance.  As an aside, we’ve talked about trying to eventually downsize our house and have her go part-time.  Without the daycare costs and lower living expenses, this would make the need for this type of insurance even lower.

I don’t think she’ll get seriously injured or sick more than every 6.5 years, and the potential $800+ in annual savings sounds great.  It seems like a reasonable risk for us to get rid of this insurance and save the money.  We need to think through it a bit more, but I think we’ll end up dropping this insurance (during open enrollment in the Fall).

What about you?  In the end, it all comes down to your own personal risk vs reward trade off.  Do you carry short term disability insurance or have you decided that the risk vs reward trade off isn’t worth it to you?

One last item I feel needs mentioning – it can be important to have health insurance if something does go wrong so you can at least cover the bills if you’re out of work.

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