Interest Free Loans

Not for us unfortunately.  Unless we take advantage of zero percent financing that a lot of retailers are advertising.  That is dangerous; if you do not pay the entire purchase price back during the promotional period, you owe interest on the ENTIRE purchase.  That is a nugget of knowledge I had to squeeze in, but not the main topic of this article.  Imagine borrowing $12,000 over one year at 5% interest.  You make one payment back and at the end of the year the loan is paid off.  You would pay $12,000 * 1.05, or $12,600.  Try and pay less, you will be slapped with finance charges, late fees, increased interest rates, and everything else the creditor can legally throw at you.

Believe me; these interest free loans happen all the time, right under our noses.  What if I further told you that YOU were the creditor?  It’s pretty sneaky, and unless you really analyze it, you probably don’t see it.  Your hard earned money gets taken out of every paycheck, before you see it, and paid to the federal, state and sometimes local government.  This is very convenient if you are paying the correct amount in and at the end of the year owe $0 and get a refund of $0.  That’s how the system was initially set up.  With how complex the tax code is however, it is virtually impossible to be able to micro manage everyone’s taxes so that happens.  They try though! 

One of the first things we do when we are employed is fill out a tax form called the “W4”.  The main reason for this form is to determine how many ALLOWANCES you are taking.  They give us a little worksheet to help us figure this foreign concept out, and for many of us we have no idea what or why we put down the number we did.  I would always put down “0” or "1".

Well a “0” or "1" tells our employer to expect the worst in regards to taxes owed and take out the most from our paychecks to prepare for it.  Every year I’d file my taxes and I’d get a monster refund because of my low income and various credits and deductions I qualified for.  This refund felt like I was being PAID!  I’m sure you all know the feeling.  Turns out I really wasn’t, I was merely being refunded all the money I had been paying in throughout the year.  I pay interest on all the loans I have, but I didn’t receive any interest for the loan I had just made to the government. 

In this economy it’s hard to get 5% on any investment, but even 1% of $12,000 is $120, and that’s about what I could have made, had I put that same dollar amount into a savings account.  (Note – I didn’t pay anywhere near that much, this is just an example!)  According to the IRS website, 324.1 BILLION dollars of refunds was sent back to tax payers from their '08 returns filed.  I tinkered with my W4, cautiously at first in fear of suited men taking me away.  I never was, and now what I do is claim EXEMPT!  Not the entire year, just January through something like September or October, depending on how much I think I’ll owe.  Don’t know how much you’ll owe?  Look at last year’s return!  It is usually a good indicator, especially if not much has changed in your life (new kids, new house, new job). 

One major responsibility a financial planner has for clients is managing taxes and minimizing tax liability.  Anyone dealing with the markets and investing has to combat a risk called Beta already (briefly described in an earlier post), they also combat taxes.  It’s not terribly difficult to plan for them on our own, and look out for a future post from me to help you do just that.  For now though, give a minute to think about that concept of free lending we are doing to Uncle Sam.