3 Reasons You Shouldn’t Receive a Tax Refund Next Year
The weather is warming up, birds are singing, snow is melting and people are smiling. You know what that means? Tax refund season is in full swing.
I’m always a bit baffled when folks act like they’ve just won the lottery or received an unexpected bonus when their tax refund arrives. I want to shake them and shout, “That was your money in the first place.” I know certain people purposely request their employer over-withhold taxes from their paychecks so they receive a big refund every year. In fact, according to a survey from the American Payroll Association, nearly 45% of Americans say they’d prefer a big refund over a larger paycheck throughout the year. As a result, the average individual income tax refund for the 2020 filing season was $2,549, according to the IRS. I say that this is a bad idea.
Here are three reasons you shouldn’t receive a tax refund next year:
Check Out: What Americans Do With Their Tax Refunds
1. You’re Earning 0% Interest on Money You’re Giving the Government
If you have debt of any kind — credit cards, student loans or a mortgage — you’re better off paying down those interest-charging accounts rather than letting Uncle Sam hang onto your money interest-free.
For example, let’s say that Alicia has several credit cards with balances totaling $15,000, with an average interest rate of 15%. If she’s receiving the typical refund of $2,549 (which could have been used to pay down debt), it’s costing her $382 in interest to overpay her taxes each and every year she’s carrying a credit card balance. Even if you don’t have high-interest debt, you could be investing that overpayment in your retirement account and earning compound interest.
2. You’re Living Paycheck to Paycheck
In my early 20s, I was a hot mess with my finances. I lived in a constant state of stress because I had no margin in my money. Any unplanned expense — car repairs, an unexpected vet bill, Uncle Joe’s retirement gift — would blow my budget out of the water. But when tax refund time rolled around, I enjoyed one or two months of worry-free spending.
Seventy-eight percent of U.S. workers live paycheck to paycheck, according to CareerBuilder, and I’ve coached countless clients in this situation. My advice: adjust withholdings to minimize the amount of your refund, so the additional money every paycheck relieves that stress. Using the average refund of $2,549 as an example, that would put $212 more per month in your paycheck. I’d much rather see you adjust your withholdings so that your refund is very small, so that you have more financial breathing room all year long.
Find Out: Everything You Need To Know About Taxes
3. You Can’t Access the Overpayment Until Filing Time
If you don’t have an ample emergency fund to cover a large expense (medical emergency, job loss, home maintenance), you might have no other option than to rely on debt to cover it. Even if you’ve already overpaid your taxes by several hundred or thousand dollars, you cannot access that overpayment until tax time. Instead of overpaying your taxes, request that your employer split deposit your check and put that money into your savings account.
Here’s the biggest objection I hear to not getting a refund: “I don’t trust myself to use that extra money wisely.” The solution is to set up automatic transfers from your paycheck or checking account to go straight toward paying debt or into a savings account. Do this when you receive that first paycheck with the positive adjustment so you’re not tempted to spend that extra money instead.
Overpaying your taxes is like opening a savings account that pays zero percent interest, and you can only access it once a year. Rather than getting a tax refund of several thousand dollars every year, adjust your withholdings — with the assistance of your CPA or tax professional — and put that money to better use to help yourself make progress on your journey to financial health.
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John Csiszar contributed to the reporting for this article.
Last updated: Feb. 24, 2021