Is Getting a Tax Refund a Smart Way to Save?

Congratulations! You filed your taxes and scored a tidy little refund.  Who doesn’t love a nice surprise? Millions of Americans actually look forward to filing their taxes every April because they like surprises, too.  They expect to get a windfall of cash in the form of a refund from Uncle Sam.  About 78 million tax filers received federal refunds averaging $2,833 for the 2018 tax year.  But is getting a tax refund really the best way to handle your money?  See if you can relate.

You’re a Terrible Saver 

Don’t feel bad, most Americans are not expert savers.  The news organization CNBC shared a report in 2018 showing almost one-third of Americans have less than $1000 in savings.  Tax refunds are a kind of “forced-savings” plan.

PRO:  Using a tax refund could be a strong choice if you don’t have the discipline to set money aside and leave it alone.  With today’s super low prime interest rate, the interest earned in a standard savings account is almost zilch.  If your tax refund is a few thousand dollars or less, you haven’t missed out on very much interest earned.

CON: If you find yourself going into – or living on – revolving (credit card) debt regularly,  know that having access to your refund dollars (rather than letting the IRS keep your money for you) could help you avoid some pretty painful credit card fees.  When you consider the hefty interest rates credit companies charge, you’d have done far better paying down your credit card with those lay-away tax funds.  The IRS doesn’t pay interest.  But US News and World Report’s list of top credit cards show some APR’s as high as 26%.  Ouch.

You’ve Always Gotten a Refund

Why upset the apple cart, right?

PRO:  Some of us just don’t feel like we’re that good at managing our money.  It’s easier to leave things as they are and get a nice bonus in the Spring.  If your refund is modest (less than $1,000) and you don’t have the time or inclination to fiddle with a new W4, you could let it ride for now.

CON: Unfortunately, if you’re just blowing your windfall and not using your tax refund strategically, you may be missing out.  At some point, you’ll probably have to be more hands-on with taking charge of your money.  Since the refund owed to you by the IRS represents an interest-free loan you’ve made to the US Treasury, you may want to ask who would make better use of it – you or the IRS? Also, as you earn more or change jobs, you’d be wise to double-check your tax withholding every year no matter what.

You’d Rather Be Pleasantly Surprised than Owe the IRS More Money

We get it.  You don’t want to experience the pain of an unanticipated tax liability.

PRO: Again, if your refund is nominal and your income and lifestyle aren’t likely to change soon, you may be making the right call.  And certainly, no one wants to face going into debt to pay the federal government in April.  You may also not be a hard-core saver (yet), so staying the course keeps you out of trouble.

CON: Sure, letting things ride is easy and safe, but it’s not that hard to estimate your taxes properly. If your refund is getting larger rather than smaller, it’s time to take charge of your withholding and put more of your hard-earned money to work for yourself during the year.  As tax codes change and life’s circumstances evolve, you’ll want to be sure your tax withholding is deliberate in order to avoid an unpleasant tax bill after all.

TAKING CHARGE OF YOUR TAX REFUND

Sometimes change is good.  If you’re ready to right-size your tax withholding, not only is it easy to accurately estimate your federal taxes – there’s plenty of help.  Here’s what you need to manage your tax situation like a pro.

  1. Find an online tax withholding calculator. (Most online tax services provide a tax calculator based on the tax data you’ve already given them.)
  2. Grab your latest pay stub and notes on any other sources of income you expect.
  3.  Use the calculator to zero-in on the actual amount you’ll owe in federal taxes. Then complete the W4 form accordingly.
  4.  Get this new, revised W4 into the hands of your employer or HR person right away.

In as little as 30 minutes, you may be on your way to a slightly fatter, smarter paycheck.  If you already use automatic deposit for your paycheck, it’s easy to have this extra sum dropped neatly into your savings account.

That’s called having your cake and eating it, too. Check out our series on smart planning for the upcoming tax year and feel free to contact us with other questions about managing your money.