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It’s that time of year when the mainstream media will begin chastising you for ending up with a tax refund instead of perfectly managing your prior year tax situation to avoid getting a check from Uncle Sam. To do otherwise would be giving the government a free loan, right? This view has been espoused annually like clockwork.
The thinking goes that since you don’t receive interest on the refund you get at the end of the year, in effect, you’re lending the government money at a 0% interest rate when you could have been investing it yourself throughout the year. Well, I view this critique as an inability to see the forest through the trees — much ado about nothing.
According to the IRS, the average tax refund was $2994 last year, a slight increase over the year prior. Based on this amount and the rationale below, you may end up feeling a little less guilty this year when you collect your refund check this spring. (See also: Find Out When Your Tax Refund Will Be Sent)
It’s Nearly Impossible to Get it Just Right
With all the various tax credits, deductions, multiple sources of income and other facets of our complex tax code, the odds of setting your withholding perfectly during the year to end up anywhere near a zero refund are quite low. Personally, I view this as a futile exercise, especially if it’s a difference of a few hundred dollars in the end. Couldn’t your time be spent on something more productive? If you put that sort of time and effort into researching ways to earn some extra money on the side, figuring out ways to save more money, or optimizing your existing investments, that may be a much better use of your time and resources. (See also: 10 Most Overlooked Tax Deductions)
The Free Government Loan Doesn’t Matter at These Rates
While many people irrationally focus so much on NOT paying taxes that they actually make poor investment decisions (like selling “losers” in December for the tax loss, even if it doesn’t align with their long-term investment strategy) or make charitable donations they can ill afford, likewise, some people abhor the idea of “loaning” the government free money so much that they can’t envision themselves receiving a refund the next year under any circumstances.
The reality is interest rates are at historic lows. With the average refund above of close to $3000, considering the fact that this amount is accrued across the whole prior year, let’s say at an annualized rate you’re “lending” the government $1500. With the risk-free interest rate over a 1 year period sitting at under 2%, you’re talking about foregoing income of around $30 or less. The horror!
A Forced Savings Account is Better Than Nothing
Right or wrong, many people find it so difficult to save throughout the year that a tax refund acts as a forced savings account. This extra money they would have taken home otherwise is basically written off throughout the year as background noise, especially since it’s often a complete mystery just what the refund will be come spring. With that in mind, many families go through the year using after-tax income on necessities and retirement contributions but the come spring — refund!
It’s an Automatic Emergency Fund
With so few Americans having a sizable emergency fund, why not use this year’s refund to kick off such a vehicle in the event of job loss, medical emergency or other unforeseen circumstances? Since small monthly surpluses are so easy to spend and make for tough emergency fund investments, this method of getting a mini-windfall in the spring is a much more tangible and impactful way to kick it off. While this year’s refund might only be equivalent to a month’s income or so, it’s a start!
It Beats OWING Money!
Realistically, it’s unlikely that you’ll hit it just right, especially if you have investment transactions, income from savings accounts or CDs, a bonus, credits, deductions and other myriad taxable events throughout the year. With this in mind, would you rather risk actually owning money? Coming out of a costly holiday season and heading into summer, I’d much rather be seeing money coming in than going out at this time of year.
At the end of the day, you can fault the government for their taxation policies and where money gets spent, but is it really worth burdening yourself with trying to micromanage a tax return when the downside cost equates to peanuts? By taking a look at this summary of Federal tax law changes for 2010, it’s evident it’s more work trying to keep up with the latest moving target than just focusing on the low-hanging fruit.
This is the first year I owe the government and I hate it. It's a couple thousand dollars, and it hurts! I have plenty of money to cover it, but cutting a big check to them is terrible!
While I hate the idea of giving the government a loan, I think I hate giving them a bunch of money all at once, too. Kind of a lose-lose scenario.
Just as you said, it's a forced savings account! Unfortunately some of us need that. Though regarding the rates, I wouldnt have my money in a low interest earning savings account anyways, Id put it in dividend stocks so it can grow and outpace inflation.
For us personally, I've found that the extra kick in April gets spent as quickly as it comes in because it feels too much like "free money." I do a much better job of managing the extra couple of hundred dollars on every paycheck.
I've been targeting the $0 refund for 3-4 years now, and always manage to get within a couple of hundred dollars on the plus side. With IRS's calculator and relatively simple taxes, I think most people COULD get it close if they wanted to.
Different strokes for different folks, for sure, but I've just found that the opposite works for us! :)
Count me in the "no giant refund" camp. It is almost impossible to owe nothing and be owed nothing by the government, but $30 is $30. Everyone should do their best to limit the amount of refund they receive so they don't view it as free money to blow.
This is the first year that we have received a significant refund. Unfortunately, we could not predict my husband losing his job last year and being ineligible for unemployment. This left us with only my income to support our family, which put us in a much lower tax bracket. In addition to that, we have a child and my husband went back to school full time to finish his degree. Thankfully, our income tax refund helped pay off some debt!
To play devil's advocate...if you have to pay bills on credit cards because you are having too much withdrawn, it could be bad from the standpoint of having to pay interest instead of having cash to pay for something.
While it's certainly unrealistic to be able to predict the exact amount of tax you'll owe, and that the interest to be gained is next to nothing, we should all aim to be more responsible that owing a reasonable amount on taxes is no big thing. We shouldn't fall prey to the psychological trick that because we're writing a check to the government instead of having it withheld that we're paying more. And if we do feel more pain in having to manually write a check to pay our taxes, perhaps it would encourage us to write our representatives to make sure they're using our taxes responsibly and the way we want them to. These are several reasons why is ok not to get a tax refund.
For me, success is owing just enough that I don't get penalized.
Getting a refund is failure. It means I paid too much during the year.
Why would any normal person feel guilty about getting a refund? It's YOUR MONEY to begin with! The government was just taking it from you.
Amazing. It seems there's nothing new under the sun - we have all the same issues with tax in the UK!
I actually prefer getting a refund to trying to get it down to even or actually owing a few bucks. It's just a nice surprise no matter how many times it happens.
Pure propaganda.
Keep that interest free flowing to the government instead of doing just a little math and owing as much as you possibly can without incurring penalties and putting that underpayment in your savings account or other short-term investment until tax time comes around.
Yeah, that's the ticket!
Wow, lots of great opinions and strategies in there. So, this appears to be as much a personal preference issue as it is a purely financial evaluation!
I am a CPA and I spent 20 years preparing income taxes. I completely agree with this article. I disagree with the common personal finance advice that it is poor planning to get a big tax refund. The point made in this article- that interest rates are so low that you would not have made much if you had put the money into a savings account it true. Also, many people don't have the money saved to write a check to the IRS if they underwithheld. I believe that most people, if they adjusted their withholding so they had less income tax taken out and a bigger paycheck every payday, would simply spend the money. It's easy to spend an extra $50-100 per month without thinking about it. If you end up getting a big tax refund, it is like an automatic savings plan. At least you will think about how you will spend a $2,000 refund.
Another factor, at least here in California, is that the federal and state withholding tables don't work well together. If you claim married-5 dependents that may work for your federal taxes but you could end up owing money to the state or getting a big state refund. If you get a small refund from the state you may get a big refund from the feds (or vice versa). You can file a form so that you claim a different number of dependents for state withholding than for federal withholding, but many people don't realize this.
So if it's a forced saving plan why not do an actual savings plan? "Only" $30 - ok, why don't you send it to me, I'm sure you won't miss it.
I used to feel guilty about getting more than I paid in. Here is how I look at it now. I receive from my employer (by way of the U.S. Government) what he should have paid me anyway. If it weren't for people like me, the rest of you would have to get a real job. I add value to the GDP, like farmers, fisherman and miners do. So all you smart people that can wear the same clothes tomorrow that you wore today because you didn't get anything on them? Thank you!
I never considered that anyone would think it was bad to receive a refund. I suppose I could save to owe the government a little bit at the end of the year, but I still prefer receiving a refund check in the mail. I think it's just personal preference, especially when you consider that I put the money from Uncle Sam into a savings account. Getting the refund just helps me be more fiscally responsible.
