Stop Feeling Guilty! Why Getting a Tax Refund Isn’t Such a Bad Idea

tax refund checkI love getting a refund check from the tax man during tax season! Of course, whenever I say that, I almost always get chastised by somebody who tells me I’m crazy for feeling that way.

Indeed, most income tax experts advise us to take advantage of a tax-planning strategy that provides more take-home pay over the course of a year as opposed to a big refund once a year. The conventional wisdom is that it’s better to increase your federal income tax withholding exemptions, which then results in higher take-home pay, which can then be invested in an interest-bearing savings account.

The fact is, most of us don’t get that much dough back from Uncle Sam to make a difference. For this reason I prefer to get a tax refund at the end of the year. If you carry no credit card debt and have your bills under control, then you may want to consider getting a refund too.

How much extra cash do you stand to lose each year by letting the tax man hold it?

Well, in 2014 the average US federal tax refund was about $2,831. With that in mind, let’s assume you adjust your withholding allowance on your W-4 form to avoid a refund. If you placed that $2,831 into a one-year CD — where rates currently average about 1.1% — your cash would earn $31. Big deal. In essence, that $31 represents the opportunity cost of having a forced savings account.

Here’s the rub with CDs: The additional income you receive by increasing your exemptions is spread out incrementally across the entire 52 weeks. So most people put that cash into a traditional savings account paying a much lower interest rate instead. How much lower? Well, if you’re not a careful shopper, today you can easily find banks offering just 0.01% interest! Over the course of the year, that would return … 28 cents. I know.

The funny thing is there are countless banks and credit unions that still use the ubiquitous catch phrase “Watch your savings grow!” Frankly, an acorn transforms itself into a mighty oak in far less time. In fact, with the paltry rates banks are offering today, savers have to live to the ripe old age of 10,000 before they’ll see any results. But I digress.

Claiming fewer tax withholding exemptions is a great way for many people, especially those that are undisciplined, to maintain a forced savings account. It also offers a guaranteed windfall each spring that can be used to pay for big-ticket items or help meet long-term household financial strategic planning goals.

True, if you have high-interest credit card card debt, are having trouble paying your monthly bills, or expect an extremely large tax refund, then by all means increase your withholding exemptions so you can take advantage of the extra cash all year long.

Otherwise, there’s really no significant advantage either way. That is, unless inflation comes roaring back with a vengeance. Or you plan on living a long, long, long time.

Photo Credit: frankieleon

Comments

  1. 1

    Jacob Stewart says

    You will do much better to have some discipline save throughout the year and invest in something other than a cd. Invest in something like a mutual fund or individual stock.

    • 2

      Len Penzo says

      To each his own, Jacob. The fact is, a lot of people don’t want the risk or don’t want to do the research that’s necessary to invest in stocks — especially in today’s over-priced markets.

  2. 3

    says

    Claiming more exemptions to have a higher net now is great in theory, but how many people actually invest that income? The fact is that the regular Joe isn’t going to do it, therefore it’s better to have Uncle Sam hold it for you — that is, as long as you don’t blow your tax refund every year on large purchases.

    • 4

      Len Penzo says

      I agree, Ben. I think most people either tuck their refunds into their savings account or, more likely, spend it.

  3. 5

    says

    I am with you, I like my refund and I don’t care what anybody says. I usually take my refund and invest it anyways, but I don’t have to worry about having to owe money at the end of the year… even if it costs me a few dollars in interest.

    • 6

      Len Penzo says

      Rather than invest it, the Honeybee and I usually spend ours on something — either to help pay for an upcoming vacation, or some big-ticket item we’ve had our eye on.

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