Tax Refunds Are Not Ideal, But Are Still Useful

Many people get excited around tax time. Who doesn’t want a few extra hundred or thousand dollars in their pocket? The more, the merrier. Do you really understand how tax refunds work?

You may have read - or have been told – that getting a tax refund isn’t necessarily a good thing. Having Uncle Sam send you a big windfall just means your employer over-withheld Federal taxes from your paycheck last year. Sure, you could have been doing other things with that money, like putting it in a savings account, investing in your retirement or paying off debt. You know what? It’s not too late to do any of that.

A tax refund may not be such a bad thing for someone who lacks the discipline to stash away $200 or more each month. Since taxes are deducted from your paycheck before you ever touch it, “saving” is painless. Plus, you can’t withdraw the money on impulse and you might not even earn all that much interest by just contributing to a savings account or CD. Giving a 12-month loan to the IRS isn’t the worst thing you can do with your money, especially if you wouldn’t have done anything better with it throughout the year.

The key is not to waste your tax refund once you get it (and forget about refund anticipation loans). Remember that a tax refund isn’t free money from the government. It’s money that you worked hard to earn, so you don’t want to blow it. Instead, use the refund to meet some of your important financial goals like paying off debt, building an emergency fund, saving up a down payment, or saving for retirement.

While there are some very good things you can do with your tax refund, there are also some very unwise ways to spend the money, e.g. shopping sprees, vacations, new electronics, toys for the kids, and other things whose value drops significantly after you’ve spent the money.

With so many exemptions, deductions, and tax credits, it’s pretty hard to breakeven on your taxes. An accountant or other tax professional can help you figure out the exact amount of withholding you’d need based on your salary and deductions. Even that figure could change if your financial situation changes or if the government changes the tax rules. Get as close as you can.

If you typically get a tax refund and you’re having trouble making ends meet, consider adjusting your withholding so there’s a little more money in your paycheck. Having a couple extra hundred dollars each month can keep you from living paycheck to paycheck and ease up the tension in your budget. Just make sure you don’t adjust too much. Otherwise, you’ll end up with a tax bill instead of a refund next year if you don’t pay enough in income taxes.