3 Reasons a Big Tax Refund Can be a Good or Bad Thing
Every year in January I like to ask people if they’re excited about the upcoming tax season.
Usually my question is met with a big smile, saying they can’t wait to get their big tax refund.
I’ll then ask what they plan to spend it on.
Why do I ask this? Because most of the time they’ve already got the money spent in their mind before their taxes are even filed.
I tell them they actually could have had this money throughout the year instead of waiting for tax day, and at that point, those big smiles usually turn into confused, blank stares.
I find it fascinating how many people view tax refunds as a gift from the government, like it’s some new found money, or a bonus for being a citizen of the United States.
In reality, a big tax refund often means that you way overpaid what you should have each pay period. It’s money you earned. It’s your money, and instead of it being deposited in your bank account, it was given to the government to hold onto for safe-keeping. They just give you back what was rightfully yours to begin with.
The average tax refund in 2019 was $2,865, or roughly $240 a month.
So here’s the debate. Does it make more financial sense to get that average $2,865 in one lump sum, or is it a smarter money move to pocket the $240 each month?
Here are 3 reasons why a big tax refund may be a good thing for you, and 3 reasons why a big tax refund may not be a good thing.
3 Reasons a Big Refund May be a Good Thing
1. You have a hard time saving money
Let’s face it. Saving money isn’t always easy. While some people seem to have a good grasp on it, if you’re like most of us, saving money doesn’t exactly come as second nature.
To save money, you need to establish good money habits, and be consistent. If you can’t discipline yourself to save in daily life, and you suddenly find yourself with a nice stash of cash in the form of a tax refund, that can be the perfect opportunity to get a nice boost in your savings.
If a refund is the only way you can save, it’s probably better for you to get it all at once.
2. You can’t trust yourself
With 78% of U.S. workers living paycheck to paycheck, once we receive our check, it’s gone by the time our next check comes in.
Money seen is money spent. Here today, gone tomorrow.
If you find yourself having some extra money each week or month, it can be pretty easy to convince yourself to spend it.
Getting a big tax refund tell means that the government holds onto your money, keeping it out of reach, and eliminates that temptation.
3. You’re not losing much money
Having too much withheld from your taxes is essentially lending the government your money free of interest.
You may already have a savings account you regularly add to, and if so, you probably know that interest rates are pretty low right now. If you’re planning on putting your tax refund into a savings account, the interest you’d gain each month from splitting up the refund would probably be pretty small.
Waiting for that big tax refund may be worth it for you, knowing that it’s a guaranteed savings strategy to net you a lump sum each year without you having to micromanage it.
3 Reasons a Big Refund May Not be a Good Thing
1. You have debt
Let’s say you have credit card debt of $5,000 with an interest rate of 18 percent. The minimum monthly payment would be around $125 and would take 273 months to pay off, and paying $6,923 in interest!
You plan to make a big dent in this debt by using your tax refund, which is a great idea.
However, you could pay it off faster, and save money on interest by adjusting your tax withholding, and use the extra money from your paycheck to pay the debt down during the year.
Using the average tax refund example above, if you applied the extra $240 a month, you’d have your debt paid off in just 16 months and only pay $639 in interest!
It’s always in your best financial benefit to pay off your debt (especially credit card debt) as quickly as possible.
2. You splurge with your refund
You view your tax refund like money falling from the sky, a gift that you wouldn’t have otherwise. You use this to justify an expensive purchase like a big screen TV, or treating yourself to a luxury vacation.
That all sounds well and good, except, it’s not a gift, it’s money you worked for, earned and deserve!
While making a big purchase might make you happy in the short-term, the money could probably be used for something better (like getting out of debt) that will make you happy in the long term.
3. You lack an emergency fund
You never know when an unexpected expense will occur, like a home repair, car repair, illness, or being between jobs.
According to the Federal Reserve’s report on economic well-being, nearly 40% of Americans can’t cover an emergency expense of just $400.
Without money to handle financial emergencies, you’ll either have to sell something, or borrow money, which only increases your debt. Stashing your tax refund as an emergency fund can be the different from financial ruin, and being debt free.
Whether you receive a big tax refund each year, or adjust your tax withholding to have more money in your paycheck, there are pros and cons to give an argument for each method.
Everyone’s financial situation is different.
If you’re already good at saving, or have no debt, you may enjoy a nice lump sum of cash in your refund.
If you have debt to pay off, or tend to spend your refund on things that don’t have a lasting benefit, you may want to adjust your tax withholding and take advantage of a bump in your paycheck.
I encourage you to consider which would be the smartest money move for you.
What are your thoughts? Let us know!