The case against receiving a tax refund

The deadline to file your tax return is rapidly approaching. To many Americans, tax return season isn’t just a bit of annual book keeping. It’s akin to a personal holiday. It’s something to look forward to. It’s National I’ve Got Some Money Coming My Way! Day.

That’s because many Americans knowingly overpay on their taxes, and then treat their tax return as an annual bonus, rather than what it really is – your money being returned to you.

A recent poll by the National Foundation for Credit Counseling (NFCC) found that nearly 60% of Americans intentionally overpay on taxes in order to receive a federal income tax refund.

"The findings suggest that receiving an income tax refund has become standard operating procedure for some people," said Gail Cunningham, spokesperson for the NFCC.

You could argue (as many do) that intentionally overpaying on taxes is the only way some people can save money. What many people don’t realize, however, is that if they can manage their monthly expenses successfully while overpaying their taxes, they could just as easily manage those same expenses while paying the proper amount in taxes, and building their savings, all with the added benefit of earning interest on those savings.

Need more reasons why overpaying on your taxes isn’t in your best interest?

  • When you overpay on taxes you are effectively loaning money to the government at a zero percent interest rate. If the money wasn’t automatically deducted from your paycheck and instead a government representative came to your door every two weeks and said, “Hey man, I need to borrow $50. I swear I’ll pay you back in the spring” would you be so excited to cut them a check?
  • If the point is to save money, you can accomplish the same thing (with interest) by having a portion of your paycheck automatically deducted each pay period and dropped into the savings account of your choice.
  • By overpaying on taxes you have less money available week-to-week, which can lead to using (and potentially overusing) credit in order to make ends meet. If you plan to use your tax refund to pay off debt, ask yourself, “Would I even have this debt if I’d had access to all of my money in the first place?”
  • How do you really use your refund? Even if you just use your refund for a once-a-year splurge, you could still achieve that end by cutting back on your taxes and ramping up on your savings. In fact, you’d be able to splurge even harder (if you were so inclined), because you'd have added interest on top of your savings.

"Often the very people who celebrate receiving a refund are those who are most in need of extra money in their pocket each month," said Cunningham. "Living paycheck-to-paycheck, people often fall behind on important priorities such as rent or vehicle payments. With the refund in recent years averaging close to $3,000, an extra $250 every month could mean the difference between eviction and repossession, yet many people remain reluctant to forego their habit of receiving refunds."

You can use the Withholding Calculator at IRS.gov to calculate the proper number of withholding allowances for your situation. After determining the appropriate number of allowances, you should complete a new W-4. Workers are allowed to submit an updated W-4 to their employer at any time during the year.

If after adjusting your withholdings you end up with a higher paycheck, you need to make a plan for how you’re going to use that extra money. You can achieve any goal, you just need to make sure that you’ve got the right goal and the right plan to get you where you want to go.

Jesse Campbell is the Content Manager at MMI, focused on creating and delivering valuable educational materials that help families through everyday and extraordinary financial challenges.

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