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).
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?!?
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
I 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.
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.