Getting a tax refund is OK, right? Well … from a financial perspective, there’s no doubt that it’s better to maximize the withholding exemptions on your W-4 form. Why? Because the resulting additional take-home pay can be invested or placed in an interest-bearing savings account. After all, the alternative is to give the government an interest-free loan every year. Even so, many people still prefer to get an annual tax refund — mainly because the guaranteed lump sum windfall makes planning easier.
The bottom line: For many people, any potential monetary gain they forfeit by over-withholding their income is essentially too small to worry about. If you’re the type who struggles to save money, you probably shouldn’t worry about it either.
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I agree 100% – especially now with interest rates so low!
My wife runs her own company, I’m to lazy to submit quarterly tax forms for her company – thus I have extra taxes taken from my check. I figure as long as we are getting a refund the IRS is not going to worry that we are not making required quarterly tax payments.
The last thing we all want to do, David, is give the IRS another reason to audit our books. 😉
i completely agree! and it is so great to hear a financial blog that agrees too!
Why do you think they call me a “maverick,” tracee? 😉
Agreed – Especially in this political climate where recently the tax laws have been changing more than ever it seems as the tax year is still going on. Also, getting a small return of say $1000 has a larger psychological benefit than saving $83.33 a month. A mix of smart money management but a few bits of positive reinforcing mind tricks is never bad thing!
Great point, Bill. I know it does for me. In fact, upon further reflection, it’s probably an even better justification for why I prefer refunds too — although it does also help us with long-term planning for big-ticket purchases.
I have to agree. Interest rates are lousy and the poor economy makes scoring larger investment returns dicey. What’s a couple of percent over a few grand across a year? A hundred bucks (before its taxed the second time around for interest or capital gains)? Forget it.
Would you believe $32.73, before taxes?
(Assumes $250/mo earning 2% interest for 1 year)
If I got the extra money in each paycheck I’m pretty sure I’d blow it. That’s why I like getting a nice refund every April beacuse it helps me save.
Good for you, Sherri. If you don’t have the discipline to save anything, over-withholding is a terrific tool because it forces you to save.
Hopefully you’re using those refunds to help build up an emergency fund and perhaps contribute to your retirement savings, if you aren’t already doing that.
Even though I try to tweak my withholdings, I always seem to get a refund. Does it bother me. Heck no!
That money is usually considered found money and gets spent on something special or needed.
Us too, John. We usually use the refund money on home improvement stuff.
Been there, filed that, got this year’s refund direct-deposited to savings already.
I absolutely agree with you. Sure it’s an interest free loan to Uncle Sam, but what’s the alternative? Earning 0.5% in savings?
In our case, there are 3 of us (wife, me, son) and one job (mine), so I withhold as M4. But we still got back a substantial refund thanks to the higher education tax credits and deductions. (I’m a Santorum sob.)
So why don’t I have more withheld? It’s like Bill says above; the tax rules change on a whim every year, and credits can disappear. I’d rather not owe taxes unexpectedly due to a mid-year rule change.
Oy … 0.5 percent. Sad, sad, sad.
It kind of makes me pine for the days when I was earning double-digit-percent interest rates on my savings as a kid (back in the late 70s/early 80s)! Oh, yes, folks. All savers were earning those rates. Dare I say it reached 18% at the peak? (I may be mistaken now, that was so long ago.)
And if those rates ever return — and I betcha dollars to donuts they will — you and I would be foolish to continue over-withholding!
Did I say 0.5% interest? I was optimistic. I looked up the current rate at my credit union for a savings account: 0.25%
When I was a kid, a savings account typically earned 4%. Then, as you say, things began to jump in the 1970’s. I recall my father having an 18% mortgage at one point. Things were cooling off by 1983 when we bought our first home — a typical mortgage was 12.5%.
We have a few savings bonds purchased prior to June 1995 that are still earning 4% to this day. Not a great return at the time, they sure look wonderful now. They were originally purchased as part of a college savings fund, but we’ve held on to those puppies and found the college money elsewhere!
In Canada we were getting those 18% or so rates on government savings bonds around 1980-81, I think. But the poor folks arranging loans and mortgages over that couple of years, yikes!
Meh…. My refund the other year was around $9. It would probably cost more in gas to drive over to where our headquarters is, as I work offsite, to change the W-4 with HR.
Well, the ideal answer to this debate is to do exactly what you’re doing: neither over- or under-withhold and get as close to $0 as possible.
Works for me!
and just another reason to prefer the “sales tax” over the “income tax” too. you pay just the amount owed, nothing more, nothing less.
I’m with ya, Griper. Unfortunately, the politicians have a vested interest in keeping the status quo. It’s up to the electorate to ensure it installs politicians into office who are brave enough to make the tough financial decisions required for the long-term viability of our nation.
Well, I’ll leave that as an exercise for the student, KC! LOL
Like you suggest, the answer will vary from person to person, so everyone will need to run their own numbers to answer that question. 🙂
Is there such a thing as an enormous refund? Nothing is enormous to me! 🙂
I know you don’t blow your income tax refund, but too many consider it found money and blow it.
IMHO if you are making 20 grand, a thousand dollar refund is too much. Make the payroll tax adjustment, but if you feel better with a refund, keep the refund small relative to income.
Like you I don’t sweat over small numbers, but I think this is one situation that a blanket policy is too broad. As long as people are “thinking it through” rather than just accepting a huge refund, I’m cool. (not that anyone cares….)
Nice to get a lump sum at the end of the year. Most probably clear a few bills with theirs.
Sometimes a large refund can not be controlled. A family of 5 earning $50,000 per year or less ( insert link to Len’s $40,000 per year earning post here) should expect most of the $1000.00 per child tax credit as well as some Earned income tax credit. These can only be claimed when the tax return is filed and may lead to a large refund. These people would be part of the 49% who do not pay federal income tax but, if they are younger than 40, they are part of the 100% who are getting hosed by FICA.
I personally don’t mind giving the government a little more money every paycheck as long as I get a good tax refund.
Is this an old post? 0.5% interest. I’m getting 5%. I prefer to pay the IRS as little as possible while avoiding a late penalty fee. No free loans from me! But as noted, as long as the amounts are not extreme, the issue not worth spending mental energy on.
For all hate directed at the IRS, there were a couple times in the past where I made a mistake on my return and they detected the error, resulting in a lowering of my taxes due
I was once contacted by the IRS because I too overpaid, Frank. It does happen.