Proud of Your Giant Tax Refund? Congrats, You Just Gave the Government an Interest-Free Loan
Written by
Vance Cariaga
Edited by
Zuri Anderson
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Keep this in mind when you celebrate that big tax refund this year: The money you’re celebrating has always been yours.
It might feel like a sudden windfall, but it’s not. It’s essentially an interest-free loan you gave the U.S. government through payroll tax deductions — you just didn’t collect it until many months later, after you filed your tax return and Uncle Sam finally paid you back.
GOBankingRates breaks down how this works and how you can adjust your finances to keep more of your money.
How Does This Work?
Refunds are “simply the government returning your own money — money that you overpaid, expecting no interest in return,” according to a blog from GYL, a California-based provider of accounting, audit, business advisory and tax services.
Tax refunds might serve a useful purpose for some people, such as those who have a hard time saving money on their own. In this case, exchanging a bigger-than-necessary payroll tax deduction for a one-time refund might make sense.
But for everyone else, that exchange amounts to lost financial opportunity, experts say.
“The IRS uses your overpaid taxes throughout the fiscal year, only to return them post-tax filing, without any financial benefit to you,” GYL noted. “Commonly this interest-free loan to the government is inadvertently costing you money that could be generating interest or invested for potential gains.”
Pisenti & Brinker, another California-based financial advisory and consulting firm, offered a similar take in one of its blogs, suggesting that “smart taxpayers understand that refunds actually cost them money.”
“Kept in your hands, those dollars could have been productive,” Pisenti & Brinker added. “For example, you could have invested the money or used it to pay off your debt during the year. If the money had been added to a 401(k) plan, tax would have been deferred on both the investment and its earnings. Even better, your employer might have matched all or part of your investment, adding to your retirement savings.”
If you’d rather keep more money for yourself each paycheck rather than loan it to the government, the best solution is to set up your payroll withholding so that you more or less break even during the tax year. This means that when you file your tax return, you won’t owe a lot in taxes or qualify for a big refund. Ideally, the dollar amount on either side of the equation will be minimal.
You can figure out the best amount to withhold by consulting with a tax advisor, financial professional or your employer’s HR department. You can also use the IRS’s tax withholding estimator. The right amount depends on a few different factors, including your household income, number of dependents and filing status.
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