25 May Myths vs. Truths – The Truth About Tax Deductions
– Exposing the false beliefs of the financial world
Myth: You should avoid paying off “good debts” like home mortgages so you can get a bigger deduction on your taxes.
Truth: Making any financial decision based solely on the amount of a tax deduction is a really, really bad idea.
This is really a matter of simple math. For most of us, taxes take 25 to 30 cents of every dollar we make. So spending money for the sake of a tax deduction means you are willing to spend $100 to save $30 in taxes. So in a practical example, if you have a $100,000 mortgage at 6% interest, you are paying roughly $6,000 per year in interest to the bank to avoid sending $2,000 to the IRS. Where does that make sense? The truth is we are so afraid of paying taxes that we over-rationalize to ourselves until we are convinced that it makes sense to borrow money to save on taxes.
So why do we hear so many CPAs and investment advisers telling you to keep your mortgage and not to pay it off early? Is it because they can’t do simple math? Well, in their defense, they were trained to think in other ways. CPAs and accountants focus on saving you money on your tax return. When they focus so intently on the number at the bottom of the paperwork, it’s hard to remember the big picture.
And what about investment advisers? Well, they know that every dollar you delay in investing costs you in long-term return on your investments thanks to the time value of money. So they do the math and figure in the appreciation of your house and the average return on your portfolio over time and reason that mathematically you are still better off keeping the mortgage payment. But what they neglect to factor in is the risk involved. What if the house depreciates and the market drops in the same year? Yeah, right- like that would ever happen! Oh, wait – it did just happen. And then there’s inflation eating away at your return. So when it boils down to it, you’re not really gaining as much as the calculations on paper say you are.
Please don’t misunderstand me here. By all means, take the deductions if the purchase makes sense on its own (without considering the tax deduction) but never make a purchase solely because of the tax deduction. If you are eligible for a tax deduction on a purchase you were planning to make, take advantage of the deduction. Just don’t base your buying decision on whether or not it will help your taxes.
In fact, here’s a better idea. If you really want the tax deduction, why not give your money to a charitable organization? You get the same tax deduction. Wouldn’t it be a lot more appealing to be debt free and giving away everything you used to pay to get a deduction? Let that sink in for a minute. Think of all the money you currently spend on tax-deductible debt. Wouldn’t it be an awesome feeling to be able to donate that much to charity instead and still get the tax deduction?Matt Wegner is a personal finance, small business and leadership coach focused on teaching his clients the tools for L.I.F.E. (Living In Financial Excellence). Learn how to establish a solid giving plan by requesting a free planning session today or visit financialexcellence.net.