Why Getting a Large Tax Refund is Bad


The stress of doing your taxes is over.

You filed all of your forms and to your joy you’re getting back a tax refund.  And it’s a nice sized one too!

It’s awesome, right?

Not so fast.

Getting a lump sum payout after filing your taxes feels great.  But I’m going to show you that it may not be as great as you think.  There are better ways you can use your money (and it is your money).

Read on as I tell you why a large tax refund is bad.
Why getting a large tax refund is bad.

Your large income tax refund is an interest-free loan to the government

When you get back a large refund it means the government was able to hold on to your money over the past year to do with as they wanted.

And what do you get in return for allowing them to hold your money?

You get your money back.  That’s it.  It was a free loan.

Know what happens if you owe the government money for a year?

Penalties and interest tacked onto what you owe.  Even a low-interest savings account gives you something back.  So why loan your money out for nothing?!?

Inflation

As defined by the Bureau of Labor Statistics, inflation is “a process of continuously rising prices, or equivalently, of a continuously falling value of money.”

What this means is a dollar today will be worth less than a dollar a year from now.  There’s a neat little inflation calculator on the BLS site.  Plugging in $1000 for 2012 I see this has the same buying power as $1014.65 in 2013.  This means I need $14.65 more in 2013 to buy what I did in 2012.

Let’s look at this another way.

If you get a $1000 tax refund for the previous year it’s really only worth about $985!  By letting the government hold your money you’ve lost $15 in spending power!  That doesn’t seem like a good deal.

You may be inclined to spend your large tax refund

hundred_dollar_bills_moneyI hear so many people say something along the lines of “I can’t wait until I get my tax refund so I can buy…”

Getting a big chunk of change at once can give someone big eyes to go spending.  If you have the money broken out in smaller pieces in your paycheck rather than one lump sum you may be less inclined to spend it all on a big purchase.

According to a survey by Capital One, more than a third of Americans plan to spend all or part of their tax refund.  Mint.com reports that the average refund comes out to about $2,800.

So many people plan out purchases based on their tax refunds.  While it’s not a terrible thing I really think creating an automated savings plan is a far better plan, especially when your refund varies from year-to-year.  And odds are the new money isn’t being put to savings.  It’s probably going to a big purchase or to cover bills from the prior holidays.

It’s your money!

This is a simple one.

The money is yours. Why wait for it?

Look, if you like lending money out in small pieces just to have it handed back to you in one lump sum at a later point then contact me and I’ll hold it for you!  Really.  I’d love to have your money growing in my accounts.  I’ll give you back what you gave me.

You Need the Money In Your Paycheck

I get using your tax refund as a type of savings vehicle.  I do.  My wife and I do a little snoopy dance when we get a nice refund (our income had been variable the past few years so it’s been hard to adjust our W-4’s for a low refund).

But some people need that money in their paychecks!

If you’re struggling to make ends meet, robbing Peter to pay Paul all year, then a little extra in your paycheck could go a long way to helping with bills and reduce stress.  I don’t get struggling paycheck-to-paycheck when you have the power to make that better.

So what to do about a large tax refund?

The goal should be to get as close to zero as possible on your tax return (you don’t owe taxes and the IRS doesn’t owe you a refund).

Change the withholding on your W-4 form so that you can get more in your paycheck rather than pay out more taxes every pay period and get a large refund next year.

If you have questions about your W-4, and your taxes in general, then it’s not a bad idea to consult a tax professional and discuss how you can maximize your money.

Do you usually get a large tax refund?

Recommended Tax Preparation Software: TurboTax | H&R Block

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Published or updated February 12, 2014.

Comments

  1. Tell me about it! We got a huge tax return and where expecting to OWE! So, we basically lost money by lending it to the government, if only we had known…

    We also changed the withholding in my hubby’s paycheck, that will take effect this week, I am excited to see how much a difference it makes. 3k a year extra sure would be nice!

    Take Care

    LJ

    • ChrisPeplinski says:

      I make less than 1% in a savings account so big deal getting it on each paycheck.

      Also, most people have a marginal propensity to SPEND! If they get larger checks, most people will SPEND the extra money, NOT save it!

      MOST. People, not the few like you.

  2. I feel guilty you did all the work for me on my post at my Word press blog.But before I celebrate to much I Just got done busting my fanny on my original blog. Thanks for a great and timely post.

  3. TheLocoMono says:

    Depends on what qualifies as a “large” tax refund, my tax refund was about 2 percent of my earned income after deductions and taxes.

    I don’t mind paying taxes, I rather be able to invest in our country and make it grow. What I do mind is the sloppy way our country manages our budget.

  4. Free From Broke says:

    @ LJ – Good luck on your withholding. I hope it’s a nice amount!

    @ Mark – Thanks for the kind words and the link.

    @ LocoMono – I guess it’s all relative. Still, if it’s my money then I want it.

    We all have to pay taxes. I agree with you on the budget though. That’s another good reason to make sure you get your money now rather than later. Why loan extra to the gov’t if you’re not happy with how they handle it?

  5. I had a rather interesting return in 2007, I had just started a new job working customer service, mostly base pay, but a part was incentives and commission, so I ended up with a fairly large refund because of the 40% tax on commission.

  6. @ Troy – It’s gotta be tough figuring out what to withhold as your salary probably changes. An accountant may be able to help you adjust your withholding so you could see more money in your paychecks.

  7. The past couple of years we had actually ended up having to pay around 1000-1200$ because we hadn’t figured out the right withholding after my wife got a job. After adjusting it this past year, we ended up getting a small refund. I’ll take a small refund over a big tax bill any day.

  8. @ Peter – I hear you, no one likes to pay. But at least you weren’t loaning it out for free. I think a small refund is right where I’d like to be too.

  9. We got a fairly large refund, but I’m about 99% certain that the reason for that is the sales tax deduction. We claimed the sales tax on the vehicle we bought last summer and got ALL of it back (never mind that we are still paying the bank for it). However, we did something good and put that big refund towards debt.

  10. @ JMDay – Nice job putting the refund towards debt!

  11. This is all screwed up. There is no way someone should get back more that they paid in fed taxes. I am single with a decent paying job. I usually get $110 or less in returns and usually owe state. I know people who make like $18000 a year, barely pay $2000 in taxes and get $7000 refunds. This person is going to buy car. So the govt is buying her a car.

    My ex by the time she claimed my 2 kids, collected child support every month add up is almost what i make yearly.

    I have no problem with the govt paying welfare, food stamps, housing, and electric bills for the poor. But these people do not deserve these large tax returns.No one should get more back that they paid in.

    To be blunt i need my $ to help my kids go to college. If i had these types of return i could have sent my kids to private school. I am tired of paying for other peoples poor choices.

    • Do you really think people can live off of a mere 18000 a year? My husband worked at a very physically demanding job for an annual salary of 18000, (15,000 after taxes and whatnot). He injured his back and lost his job in December for calling off for some doctor’s appointments because of the strict point system his employer had. I cannot work because I unfortunately suffered a lumbo sacral plexopathy injury rendering me unable to drive. (My disability case is still pending so no income from myself.) Doctors won’t sign a medical release because of inconsistencies and weakness in my legs. We have two children to support and pay over 500 a month rent and pay our own utilities. We do collect food stamps. Unemployment claim still processing after over a month (can take up to 8 weeks). When it does process, he will only be receiving 250 a week before taxes are taken out of the check. He has been searching diligently for any type of employment. Also, the truck we were using is basically shot and would cost the same to get ready for inspections, which were due this month, as it would for us to get another vehicle. If it weren’t for the EIC and additional child credit, my family would be utterly and completely screwed. My tax refund will allow us to get a cheap, reliable, family car; allow us to pay some overdue bills; get some oil for our house; (and possibly get a dental surgery I have been needing for 6 months that I couldn’t afford because the cost is 550 after insurance). The tax credits are for people who do not make enough to make ends meet. If the credits were as unfair as you are assuming they are, they government wouldn’t have them. Even if you add together the food stamps we receive, the Liheap funds, our wages, and our tax return, the total we live off of in a year is still well under 30k for a 4 person family. We’re not going to be living in the lap of luxury because of our return, just be able to breathe a little easier.

      • I do live off of $18,000 a year, but 5 months of that year I did not have to pay rent. I moved home with my parents after graduating college with a BS in Architecture. I worked at a clothing retail store those 5 months then found a job in Sales at a small start up company where I make $31,000 a year. So I was able to manage most of my money this year after paying $3,600 of that to student loan interest. I even have a 45-minute commute on the bus to work to save money on rent. (My work is located in a very high rent university town). It’s difficult but it can be done. Best Wishes to you.

    • You can’t get a larger refund than what you paid in. It doesn’t happen.

      • Yes you can have a negative effective tax rate meaning you can get back more then you paid in federal income tax withholding. One cannot DEDUCT more then their federal income tax withholding for the year but because of the many CREDITS one can qualify for someone can receive a refund that is larger then what they paid in fed income taxes thus giving you a negative effective tax rate %.

  12. I just wrote about the same thing on my blog! I knew I should’ve googled to find this article first! Great points. I could NOT agree with you more.

  13. Those that get a big refund get it because our country takes care of the poor and makes us pay, so they can live a good life like those of us that actually work and get almost nothing as a Refund. Those that earn more should get back a big refund, but it’s not going to happen as long as we have lazy low income people living in this country.

    • I think we’re talking different things here Jose. I’m referring to people who have more withholding in their checks than they need to and end up getting big refunds.

    • Considering I worked up until the point of becoming disabled, how am I lazy? I have straight A’s in my college courses so I can hopefully someday find a way to earn an income.

      Also, how the hell is my husband lazy? He worked his ass off for shitty wages because it was the only job he could find. Times are tough.

      Instead of complaining about other people receiving the help to better take care of their families, maybe you should be more grateful that you can earn decent wages. Or better yet, maybe you should learn to be grateful that you CAN drive and you CAN work. I am not that fortunate and have cried after each and every doctor’s appointment when I get reevaluated to work or drive that my normal doctor and neurologist deny me the opportunity. According to you that makes me a lazy low income person living off the government?

  14. People earn a low income and have many children because our Government rewards them like they do to the illegals that live in this country. We pay for all of their benefits and we get ( part ) only what we pay, and nothing more. So, is this fair to those tax payers that get a low sum, while others get much more and don’t pay a penny of their money on taxes.

  15. Eliminate the EIC. Those that qualify for the EIC get back a Big Refund and it should be the other way around. If I want a Big Refund I would have to ask my employer to withdraw twice for withholding taxes to give to me back a Bigger Refund.

  16. I’m sure most of you who write here are those that DON’T HAVE A FAMILY..those who do get big refunds are those that don’t make enough for their families without any government support. We get a lump sum back but that’s only so little. Trust me we are NOT getting rich off of it. It helps..thats it.

  17. I don’t exactly understand how taxes work. All I know, is I file EXEMPT, which means they do not take ANY federal taxes out of my check. I generally only make 6-7K a year so I used to NOT file taxes. I didn’t file taxes for NINE years, why? Because I didn’t have to and I knew I had not paid into it.

    Now this last year, I caught up, filed all nine years at once. So last years taxes, my W2 says I paid $1 into Federal Taxes last year. So I thought I would get a buck back. I was wrong, thought I would be getting like $137 for some reason, I am single able-bodied male, so why would I get a refund?? Nope I was wrong. Our Uncle Sam sent me a check for just shy of a thousand bucks!

    Can someone explain how the heck that works?? Now this year, I am working as an independent contractor. I am getting concerend cause I have read that they want me to send in roughly 27% of checks into the Gov’t. I also read since this will be the first year I will be filing a 1090 or whatever that thing is called, I do not need to concern myself with quarterly payments, but something tells me I SHOULD, and just mail money in and get it back at the end of the year. What’s your take on this?

  18. Wow, the point about inflation is great…and one that I haven’t thought of! I don’t like the idea of getting an interest-free loan, but when you couple that with the fact you’re losing 3%, that makes getting a big tax refund even worse than before!

    A few years ago we got a HUGE tax refund and I’ve been working to scale things back since by adjusting our payroll deductions. This year was different for us as I was 1099 for all of my income, so we’ll have a large tax bill to pay as I didn’t pay quarterly estimates.

  19. I place a lot less of a priority on this compared to other personal finance changes you can make which would increase your net worth. Five years ago when interest rates on savings accounts were 5-6%, then yes, it was an awful idea to give the government that loan, when you could make $100 or more in interest by adjusting your rates and ‘keeping’ your refund. With rates now less than 1%, that amount is probably $10 per year, which at a certain point becomes less ‘worth it’. Many people will take the extra money in a paycheck and spend some or all of it. If you spend even $10 throughout the year, you’re suddenly actually further behind than if you’d just taken the refund.

    Also, for people who can take a big refund and make a big dent in a debt, that can give a pretty big ‘rush’ that you might not get even if you apply those payments throughout the year.

    • For sure there are arguments to not worry too much and take the big refund. Used well a refund can go a long ways to know out debt. But if your debt is credit card debt where your interest compounds against you then you are better off attacking that as soon as possible.

      Also imagine the struggling family in a tough economy where every little bit helps.

      As for your argument that the extra money in the paycheck could be spent, well the same can be said of a refund. One can easily take their refund and go out and spend more that when the total is.

      I’d rather see someone taking control of all of their finances and know where their money is and how it’s working for them.

  20. I totally agree! I try to adjust my withholding to keep my refund as small as I can. I want my money during the year so I can put it to work.

  21. Taxes are a doozie, that’s for sure. I know a family that has about 11 kids, and their tax return is upwards of 5 to 7 thousand dollars. With 11 dependents, I don’t think that they would be paying out much for federal tax, but somehow they have a huge refund. Maybe I will mention this article to them, they might be in need of a W-4 tune up.

  22. William @ Drop Dead Money says:

    We usually get a large refund, on purpose. The amount of interest we forgo is a pittance these days, so that’s not a factor. Payroll taxes are always withheld at “single, zero” – the maximum.

    Reason why it works so well for us is the “out of sight, out of mind” thing. Net pay is net pay, and you find a way to live within it. Granted, we can direct deposit into our savings account, and we’ve always done that for the car replacement fund and other savings, too. It may sound crazy, but to us it’s a good thing that the IRA savings account cannot be gotten to under any circumstances. Kind of a mental discipline thing – you can’t play games with yourself that you’ll make it up next month, kind of thing.

    Whenever we need to do something like paint the house, we tell ourselves o wait for the refund. When we get it, we have what approximates a corporation’s annual capex budgeting meeting: we line up everything that needs fixing/replacing/whatever, and then decide what, if anything, we’ll take the jump on. And there’s always a portion that ends up in the emergency fund. It’s a different kind of savings plan and it works.

    And it gives us a terrific incentive to not procrastinate and get them taxes file ASAP. (Hey, I never claimed to be totally sane…)

    So, while the logic of your argument is sound, there are instances where someone’s (illogical) mind actually makes very good use of doing the large refund thing…

    • Sounds like a large refund works for you, I respect that. I’d still rather have control of the money when I made it though. Glad to hear you put the money to good use.

  23. My employer always used to encourage me to claim more on my w4 so withholding would be less and i would not be giving the government a free loan. The problem is, if you dont have the withholding correct, you will end up owing money to the government come tax time. Most Americans cant afford to write a check to the government, even if its few hundred dollars. Tax time comes shortly after Christmas time when people have big bills to pay. Adding another bill for taxes is something most people can not do. Peace of mind by having a few extra dollars taken out each week is something most people would rather have, as opposed to a bill at the end of the year. I personally would never claim “0” on my w4 but somewhere in the middle is comfortable for most people

  24. Eric Talent says:

    I am 1000% in agreement with William (2/6/2013 comment). (And perhaps since I’m the kind of person that would use an expression like 1000%, that might help to show why the hard-to-fathom logic of giving free loans to the gov’ment works for me.) Here’s how it goes in my life: there are a lot, a lot, a lot of people around me that want stuff and actually in many cases need stuff. If I’m having a better week/month than usual and there’s some leeway in my finances, this money has a habit of disappearing just as quickly out of my account as on the leaner weeks/months. And, ok, maybe I have trouble saving myself. So, this out-of-sight, out-of-mind, I gave it to the gov’ment and they ain’t givin’ it back until March/April works REALLY well for me. I have my withholding tuned way out of correct proportion such that well over $10,000 of money that should be jangling in my pocket throughout the year is actually loaned for free to our wonderful country led by our fine leader(s). Just like William above, this turns out to have many beneficial effects in my life. (1) I literally leap ahead of the pack in my desire to get my taxes filed ASAP, rather than waiting ’til mid April or even filing for an extension. Spring is a wonderful time of year rather than a dreaded time. (2) I can actually plan for major things to get done in Spring. Stuff failing right and left around the house? Everybody be patient, Dad’s gonna fix ALL of it in Spring and maybe buy some major thing that would otherwise feel out of reach. I’ve even tried a new thing lately, which is I immediately lock up some of the money in a CD that matures right at the onset of the “Holiday Season” when I need it most. Ok, so what is the downside? It’s not sitting in an interest-bearing account? LIke (a) it would really sit there and (b) what interest? .0003%? My money isn’t worth as much due to Inflation? Inflation isn’t really all that bad these days and for me it’s worth it to pay that penalty to get all the bennies that work for me. I also use a 401K plan in a similar fashion: it’s taken away from me before anyone else can, to be given back to me when maybe all the current reality will be tamped down a bit. Having said all this, I do realize the advice given in the article is the appropriate advice for most people and is echoed by financial planners and analysts everywhere.

  25. steve c says:

    I’m claiming 1 more every year on my w4s. I use to claim 0 then 1 now 2 and next year I will do 3. I think it’s perfect to owe a grand to the IRS. It just means you borrowed there money free to invest haha. I will kick them where it hurts ;).

  26. Very informative post! Thanks for sharing this to us.

  27. I’ve always got large tax refunds before and this was the first year I actually wound up owing $61. I was excited to pad my emergency fund with the refund, but I guess that won’t be happening. I was so irritated, but I keep trying to remind myself of what you wrote. I do wish I could manage to get the amount being withheld so that I’d get a refund large enough to actually pay for the cost of filing my taxes.

    • Glen Craig says:

      Mel, if you want to cover the cost of paying to prepare your taxes here’s what you can do — take the amount it costs and divide that by 12. Now set up an automatic transfer to a savings account every month. Now you have your money. I find this is easy to do with an online savings account since many allow you to make additional accounts or accounts.

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