Is A Big Tax Refund A Good Thing?
The average tax refund right now is $3,500. If that sounds like good news to you, ask yourself this: where is this money coming from?
The most likely answer is that it’s coming from you. A big tax refund means you paid too much money to the IRS all year and essentially gave the government an interest free loan.
“That’s money you could have used during the year,” said certified financial planner Shane Stewart. “To live on, to reach your goals, whatever.”
Many people look forward to big tax returns, and already have plans for how to use the money. Stewart says that one of the best things you can do with a big refund is to pay off your credit card debt, especially if you are making just the minimum monthly payment on a high interest card.
Or you can use your refund to start an emergency fund. A recent survey by www.bankrate.com found that three in five Americans don’t have enough money to handle an unexpected car repair or a trip to the Emergency Room. Stewart suggests saving three to six months of what you spend.
And instead of a spending spree, you can put your refund to work for you. Put $2,000 into a Roth Individual Retirement Account now, and in twenty years it will be worth more than $20,000.
“The compounding effect of money is amazing” says Stewart. “The sooner you can get that monies in, the longer they have to grow, and compounding wise it can be a significant amount of money when you go to retire, depending on your time frame.”
So if you don’t want to be quite so generous with the government next year, get your refund down to zero. And if you don’t know how to do that, go talk to the human resources people at your company.
Here are the top five reasons why getting a large refund is not a good thing.
1) 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?!?
2) Inflation
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.
3) 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. According to a survey by Capital One, more than a third of Americans plan to spend all or part of their tax refund.
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.
4) It’s Your Money!
This is a simple one. The money is yours. Why wait for it?
5) You Need the Money In Your Paycheck
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.
