Did you get a tax refund this year? Before you break out the balloons and the confetti, it might interest you to know that a fat refund isn’t always cause for celebration.
What’s that, you ask? I shouldn’t want a pile of cash with my name on it? Why not?
Read on to find out what you could be doing with that money instead, and why you might want to prevent yourself from getting a refund next year.
Why don’t you want a big tax refund?
Because getting a tax refund means that you’ve just loaned the U.S. government your money—without making interest on the loan.
Offering interest-free loans is not the wisest financial move, especially if you’re lugging around credit card debt or student loans. Instead of loaning that money to the government, you could be making it work for you, and earning interest on it at the same time.
Let’s assume you received $2,763, the value of an average refund in 2017. Here’s what you could have done with that money if you’d held onto it all year.
You could save for retirement
When you let the government sit on nearly $3,000 for up to 12 months, you’re giving up a huge opportunity for savings. Instead of waiting for the I.R.S. to refund you each spring, you could up your 401(k) contributions by a percentage point or two. Over several decades, that change could earn you a more comfortable life in your golden years.
“There are ups and downs in the market,” says Jude Coard, a tax partner with Berdon LLP in New York City, “but if you’re a long-term investor and you don’t put that money in until you get your refund, you’re basically losing a year’s worth of appreciation on it.”
You could build an emergency fund
$2,800 is no small chunk of change. If you needed to pay for an unexpected medical expense or car payment, you’d probably be relieved to have it. Emergency funds don’t spring up overnight—you have to put money aside, little by little. If you don’t have one, an extra $233 a month would help you to start one up. (Your goal is to save enough funds to cover your living expenses for six months.)
You could pay down debt
A refund of $2,800 is an extra $233 a month that you could have had in your pocket. Instead of loaning it to the government, you could use that money to pay off debt — or to keep yourself from getting into debt.
“You could dedicate that extra money to paying down…balances, which could save you as much as 20% on that money,” Coard says. Even if you’re not paying that high of an interest rate on your plastic, the average credit card charges 13% to 15% in interest, so keeping your balance low (or nonexistent) is a good idea.
How to fix the problem
If you’re getting $200 back in April, there’s no need to rush to your benefits department to adjust your withholding. But if your refund is closer to $1,000 to $2,000, especially if that figure is a relatively high percentage of your income, you should consider making an adjustment.
Your best bet is the I.R.S.’s withholding calculator. You’ll want your most recent paycheck and your most recent tax return on hand to provide the necessary information to calculate your withholding. Once you find out what it should be, you can file a new W-4 with your employer, sit back and wait for your fatter paycheck.
For the financially informed, money in your pocket is better than giving the government an interest-free loan. But this only works if you have self-control. If that extra cash is just going to go towards fancy dinners and iPhone upgrades, you’re better off leaving well enough alone. For those who can’t resist the lure of fun new expenditures, overpaying on your taxes is a useful form of forced savings.
But if you do decide to take the high (paying) road, consider putting something in place to keep you from squandering your newfound funds. For instance, you can set up an automatic transfer every payday from your bank account to a savings, retirement or investment account. Or you can boost your 401(k) contributions by an equivalent percentage. Your 65-year-old self will thank you.
Need help prepping for tax season? SuperMoney can help!