For millions of people, it’s often one of the most exciting days of the year. Christmas is unbelievable! But, this isn’t about Christmas, although, it is possible that you’ll end up using the results of this day to help pay off some of your remaining Christmas liability. In any case, the day I’m referring to is tax refund day. It’s not the same day for everyone, but whichever day it falls on, it’s always exciting for anyone to get a tax refund. That big deposit is exhilarating for most and for some it almost makes filing taxes worth it. Almost. However, even though everyone loves seeing several extra hundreds, or even thousands, of dollars magically appear in their bank accounts, the truth is, getting a big refund is not really a good thing. In fact, in most cases, it’s really a bad thing.
So why would getting hundreds or thousands of extra dollars be bad? After all you can use it to pay of liability, go on a shopping spree, splurge on something you’ve had you eye on for a while, enjoy a vacation, or even add it to your savings account for another day. Those are all good choices, but in reality, if you receive a big tax refund then you are only cheating yourself. If you makes you feel any better, you’re not alone.
According to the IRS, the average refund for every American is just over $3,100, and about 80 percent of all filers that make less than $50,000 receive a refund. That’s a not a bad chunk of change, but really you are just getting money back that already belonged to you. Remember, it’s called a tax refund, not a tax gift from the IRS. That means, in most cases, your refund simply consists of money you overpaid in taxes. The one exception is someone who receives several tax credits on top of his or her refund, which in this case some of your refund is free money. But in most cases, the money was yours in the first place. You just let the IRS hold onto it for you for several months, interest free.
So here’s why that matters. Imagine if you overpaid by $4,000 in taxes for the entire year. First the IRS is making interest on that money, which if nothing else you could be earning that interest instead. But there’s more. For example, if you were living from paycheck to paycheck then wouldn’t an extra $333 a month really come in handy? Of course it would. Others in a position to do so could invest that money and get an even greater return. There are so many options to choose from, so it makes a lot more sense to trade in your big refund in the spring for a little extra cash every month throughout the year.
Now, for those who are just too afraid that they won’t withhold enough taxes and end up having to pay a penalty to the IRS, there is even a better solution for you. If you’re already living within your budget, then you could use the extra money coming in to create some savings. That money can just sit there and earn interest and it will be there at the end of the year in case you do underpay. Or, if one of those unexpected expenses that are sure to occur pops up, you’ll have the cash to pay for it. That plan covers you if you underpay and it allows you to collect interest on any money that would have otherwise overpaid.
The bottom line is, it’s your money. You can put it where you want, but if you want to have access to that extra cash throughout the year, when you need it, then you’re better off slightly overestimating your allowances on your W-4, or underestimating them by a hair. Yes, you’ll miss out on one of the most exciting days of the year, but you’ll also be using your money how you want to the entire year. So, instead of letting the IRS earn interest on your income, keep it and earn that interest yourself.
This post was published on January 15, 2018