Many taxpayers like to get a big tax refund. It feels good to get that big bank deposit. But is that really a good idea? In my opinion not if you can avoid it.
Sometimes a big refund is unavoidable. For some, in particular relatively low income taxpayers or large family taxpayers who qualify for Earned Income Tax Credit and Child Tax Credit, even if they have no tax withholding from their pay, they still will get a “refund” due to these refundable credits. If you are in the situation where you have no Federal tax liability each and every year, consider claiming exempt on your W-4 so you don’t have the most money you can during the year and you’ll still get a tax refund. But be careful – if your income goes up you need to check on how that impacts your tax return.
But for the rest of us, why is the big refund bad? It isn’t that it is bad, but that it isn’t optimal. It is optimal to get more money in your paycheck throughout the year. Here are reasons why.
1) The money isn’t working for you. The IRS doesn’t give you interest on your money that they held-unless they are responsible for a delay of getting it to you. Even if you just had the money in a savings account you would have at least made a little money on interest. But if having more money in your paycheck means you can invest a little more for retirement each month in a tax advantaged retirement account – in the long run your money will work hard for you and your future self will thank you.
2) Getting the money each month can place you in a better financial position all year, not just at “tax time.” More money each month can mean you have more room in your budget to make sure you pay off credit cards. It can allow you to save money for Christmas, instead of borrowing money for Christmas. It can allow you to slowly build up savings. You can pay debt off faster and pay less interest.
3) It makes it harder for you to develop good money habits. Good money habits lead to financial security and financial freedom. The reasons I hear most often from people who like big tax refunds: It forces me to save. I use it to pay my bills (isn’t it better to pay them every month?). I use it to pay debt (isn’t it better to pay it each month and pay less interest?). If I get the money each month I’ll spend it. All of these reasons are indicators of bad money management.
Maybe using the tax refund as your bailout each year or forced savings works for you, but what happens when the big refunds go away? For most of us the big refunds will go away. Maybe when your children no longer qualify for the child tax credit. And often as you get older the bigger refunds are less likely. Better to develop those good money habits and good money management before that happens. And the earlier you do that then the earlier you will have more financial stability and eventually financial freedom.
If you make your financial life work smoothly by getting a big refund (for those who have the choice to avoid it) each year and you are comfortable, then it isn’t bad. But in my experience it can be better if you keep more money from your paycheck each month instead. It may take some learning, some effort, and some changes.
If you need help with that, Better’s Accredited Financial Counselors® are great at helping people move from where they are to where they want to be. Contact – Better Financial Counseling Network
If you are ready to move from Bigger Refunds to More Take Home Pay, some advice on managing your tax withholding is coming soon. If you have a tax professional who helps you with your tax returns, then they are a great resource to consult as well.