Traditional personal finance wisdom is that tax refunds are bad. If you are getting a tax refund then you must have done something wrong. But you know what, I don’t care about that! I’ve gotten a tax refund every year of my adult life, and I’ve smiled every time.
They say that getting a tax refund means you gave the government a free loan. They say that you could have earned interest on that money yourself instead of letting the government use it for free. Which is true, you did lose out on some interest and the government did get free use of your money for a while. But do you really care about that? That’s the question.
The average tax return in 2011 is just under $3,000. Which if you break that down works out to $250 per month. The I-hate-tax-refund groups like to say that you could have invested that money in the stock market and gotten a return of 10%. Well investing in the stock market and loaning money to the government are not the same thing. Having Uncle Sam take a little more out of your paycheck each week with a 100% guarantee of getting it back next year is not anywhere close to investing it in the stock market. It’s more like investing in government bonds, which a one year government bond is paying almost no interest at this time.
The most likely use of any money in your paycheck would have been to buy things. Things that do NOT go up in value. Things like dinners out or clothing. So having a forced savings isn’t such a bad thing. Even if you were going to be a good doobie and increase your savings with your “extra” pay you would most likely put it into a savings account, not invest it in the stock market or buy bonds.
Savings accounts are paying about 1% give or take a quarter of a percent. If you were to put your new-found $250 into savings every month you would have earned $33 in interest! Wohoo! What are you going to do with all that extra money?
Clearly, I’m not impressed. To me, the risk of allowing that money to get used up during the year on this, that, and the other is not worth $33. I think getting a lump sum of $3,000 to actually do something with is better.
What about debt?! I hear you. Instead of saving that extra $250 a month you could use it to pay off debt. I like where this is going! Let’s say that you were going to send that extra to your credit card that has a 19% interest rate. That would save you $330. That’s a significant amount of money and worth considering a change in your plan. Ask yourself, are you disciplined enough to actually pay that extra every month? Are you sure it’s not going to get frittered away by day to day life? If you are sure you can do it then go ahead. If you are worried about it I say stick to the current plan and send it in a lump sum when you get your tax return.
That said, I changed my withholding this year so that I will stop receiving tax returns in the future. This year we are getting back about $5,000, all of which was unexpected. We changed our withholdings mid year and wasn’t really sure exactly what to claim. I think we figured it out correctly and next year should just about break even, assuming no significant change in our income.
If you want to figure out what your withholding should be first head over to the IRS website and figure out what you should owe and what they recommend for your withholdings on your w-4 (that paper work you fill out when you first get hired). Once you know what you owe divide it by the number of paychecks you get each year. The answer you come up with should be what they take out of your paycheck each pay period, on average. If you they are taking too much you will get a refund, you can have them take out less by increasing the number of dependents you claim. If they are taking out too little you might owe taxes. You can have them take out more by decreasing the number of dependents you claim on your w-4. Make a change on your w-4 through your HR department at work and then wait for your next paycheck to see the impact it makes. If you want to make another adjustment you can do that.
Do you get a refund? What are you planning on doing with it?