Though getting a big tax refund may seem great, it isn't all that. Find out what a big tax refund really means …
The first months of the new year are a great time for new starts, new possibilities, new goals.
It's also the time for a new tax season!!! (Don't all cheer at once.)
As I was checking out H&R Block Online, which is the place that I've put together my taxes for most of the past six or seven years, I saw the graphic on the right side:
It's Refund Season
How delightful! Right? I like getting a big fat deposit in my checking account a few weeks after filing my taxes as much as the next guy or lady. (Actually, I get two: federal and state.)
A big tax refund isn't all that
Now, I do get it: That refund is likely the best part of taxes, and it makes good sense to promote the feel-good part of doing taxes. And it's not as if tax refunds are all bad. It still is a financial windfall that can be put to a number of good uses.
Let's put this refund thing into a different perspective. Here's what a good chunk of Americans do:
- We work, and our employers withhold taxes throughout the year. (They have to.) They're paying our taxes as we earn the money. (Or, if we're our own employer, then we send in installments to the treasury as we go to cover our taxes.)
- At the beginning of the following year, they send us a W-2 or substitute, which summarizes how much they withheld on our behalf. (Or, we know how much we sent in ourselves.)
- When we do our taxes, we calculate how much we really owe Uncle Sam.
- Then, when we file, we either (a) send in payment if the full amount of our taxes hasn't been withheld, or (b) get a refund if we had more withheld than we actually owed.
So, if we get any refund at all, it's the result of us giving Uncle Sam free use of that money. For an average of seven to nine months.
Some reasons why we may get a big refund
There are a number of reasons why our refund may be larger than we expect or want. Some of the reasons may be “meh” but others are otherwise happy events:
- You're accepting the withholding that your employer set up. Your employer will get in a lot of trouble if they don't withhold enough, so unless otherwise instructed they withhold a conservative (for them) amount, which translates to a high amount for you.
- You got a bonus. Great thing in and of itself, no doubt! But often employers calculate the amount to withhold by annualizing the gross pay for that pay period, which means that a disproportionately high amount will be withheld from the paycheck that contains the bonus.
- You got a new tax deduction. This could be a new child, a new spouse, a big charitable donation.
- You got a new tax credit. Even better than money off of your adjusted gross income is money straight off of your tax bill. People who adopt often have a big tax credit heading their way, for a number of years afterwards.
Five reasons why a big tax refund is bad
- A refund is the result of an interest-free loan to the government. This is a way of restating what's above. It might be reason enough by itself not to make that refund any bigger than it has to be!
- Withholding too much throughout the year means smaller paychecks. If you get paid weekly, and had a refund of $2,080, then this meant that $40 too much was withheld from each and every weekly paycheck. What could you do with an extra $40 per week take-home?
- Smaller paychecks throughout the year work against building up savings. That $2,080 refund could be socked away throughout the year in a savings account, $40 per week. Having a little bit more breathing room each month can make it easier to save.
- A big refund can be a big expense waiting to happen. Even though refunds can be put to good use, they just as easily can be put to what might be less-productive uses. Nothing wrong with a cruise, but … would you go on the cruise if you hadn't gotten the wad of cash all at once? There's the temptation to think less at these times.
- It's completely avoidable. If your employer is withholding too much and you are getting a big refund, you can tell them to withhold less by filing a W-4, Employee's Withholding Allowance Certificate with your employer. Additionally, the IRS has a withholding calculator available to help you with this.
Reduce your tax refund for next year, and put more money in your pocket this year!
Discipline is key if you decide to take away the opportunity for a refund. If you get a $5,000 refund, all of your points are valid, but if you’re the type of person that, if getting that $5,000 spread throughout the year, will tend to spend money with a larger paycheck, and you only end up with $4,000 at the end of the year, then which is really better? In some cases it might be seem counter intuitive, but getting 0% return is better than getting a negative return.
Good point. I suppose one way to handle it would be to set up an automatic transfer of the “overage” to a savings account so that it isn’t there to spend.
It is all about the psychology of the individual. Each point you make could be turned around, it seems to me.
1. Is an interest free loan such a bad thing when interest rates are so low that savings earn next to no return.
2. One could just as easily fritter away the extra $40 per paycheck as put it towards savings.
3. Having the money come all at once could be a way to devote it to savings, when it all could have been spent if coming in small amounts with each paycheck.
4. A person could rationalize paying for a vacation for a variety of reasons. I suppose a big amount of money in hand is one. There are worse ways to fund a vacation than using a tax refund. At least if one does that, it is better than charging a vacation or, God forbid, taking out a cash advance when the offer in the mail comes, saying, “Don’t you deserve a vacation today?…” Still, nothing prevents a person from using it for productive means, if she desires.
5. There is a benefit in knowing that come April 15th, you won’t owe the government.
I agree that a huge refund is not the ideal, especially for those who are not making a large enough 401(k) contribution to receive an employer’s full match. Still, I have heard first-hand testimony from people who use it as a forced savings account and use the refund productively. Like all financial decisions, there is no one-size-fits-all answer. Use the system that fits best with your personality and psychology.
Thanks for stopping by, Daniel. Excellent points. A good follow-on article would be: “Big Tax Refund: Five reasons why you want one” 🙂
But you’re right; it does depend on the individual. And to be fair, I do know from experience that it is a bit of a relief to get those big deposits in our checking account. There is that part of me that does want to control the money a bit more, I suppose.
Why should I be required to file a return if I have paid my tax. If at all, I may simple have to declare the same without any calculation required with details of my accounts. That all. Why I have to prove that I am not a thief?
This link will lead you through some questions to see whether you have to file or not. And I do know that you can let the IRS calculate your tax for you under some circumstances.
Thanks John for that link. I had the same question as Vanna
I personally prefer to have a big refund once a year; I’m liberal, so I don’t have a problem with loaning the government money at no interest, and it’s a better form of savings for me because it’s enforced, and it’s like an invisible number; I can see how much I have in my savings account, so it’s part of my “worth” and I can access it if I want to, whereas my tax refund is “free” money that I’m not counting on having. It’s a system that works well for me.
Thanks for commenting, Pamela! One thing I might take away from your argument is that a big part of what’s in favor of getting a large tax refund is psychological. And I do see that.
I think for most folks, it does not make all that much of a difference if you get some money back or own money. Unless you are getting a refund greater than $3k+, I don’t think one should really worry about it. If it is higher than that, then taking action could mean that you can invest the extra each month and come out ahead.
Thanks for stopping by, Derek! And yes, it really does only matter much with a bigger refund.