Finance Globe

U.S. financial and economic topics from several finance writers.
6 minutes reading time (1192 words)

A Big Tax Refund is Equal to Losing Money

Overpaying your taxes all year long to get a tax refund the next year is a terrible way to save money. Do you really want the government to be in charge of your savings plan? Intentionally overpaying your taxes literally takes money out of your pocket, and out of your control.

Some people like to get a big tax refund because they think they don't miss the money that was withheld from each paycheck since they never saw it. If that were the case, why are they so excited about finally receiving their income tax refund? It's because they have a long list of things they want to do with the money, things they could have taken care of throughout the year if only their paychecks were a little bit bigger.

Some people like that "saving" money by overpaying their income tax is a no-brainer. They don't have to do a thing; their money accumulates until they receive a lump sum that's big enough to cover a few major expenses. These taxpayers aren't confident in their own money-management skills, or they are afraid they lack the discipline needed to save their own money. Do these people really need someone else to hold their money for them? No. They just need to take control of their savings plan, just like they successfully take control of every other aspect of their lives.

Don't let the IRS hold your money, interest-free, all year. Your money would do more for you if it were put into a savings or money market account, where you could earn interest. It won't be much, with the interest rates that banks are paying these days, but a half percent is still better than no percent.

An even better option is to purchase Certificates of Deposit from your bank or credit union. CDs are often sold in increments of a thousand dollars, but some financial institutions allow minimums of several hundred dollars. The current interest rates are typically in the range of 3-4%, depending on the maturity term of the CD.

The only real drawback that most savers see in a CD is that you may pay a penalty for cashing in your CD before the end of the term. If you're a recovering tax refund saver, that shouldn't bother you because you're used to putting your money where you can't touch it for a while. Just makes sure you won't need the money before the maturity date when you decide on the term. CD terms typically range from 30 days to 5 or more years.

The negative effect of your interest-free loan to the IRS is compounded if you have a balance on your credit cards or a mortgage to pay. The average American's tax refund is somewhere in the vicinity of about $2400. If you normally get a refund of $2400 a year, that's $200 every month that you could use to pay down high interest loans or credit cards.

Make bigger credit card payments every month, rather than the minimum payment all year long and one large payment once a year. Why let interest charges accrue all year when you can reduce the debt as you bring home each paycheck? Don't allow your money to be tied up with the government for free while you're paying interest on your own credit accounts!

If your debts are all paid off, you may be ready to start putting money away for your future needs. You may want to save for a down payment on your first house, the kid's college educations, your retirement, or a dream yacht. If you have some time before you'll need the money, go one step further than simply saving your money. Invest your money.

Individual stocks are a little scary for the new and inexperienced investor, but overall, the stock market has outperformed every other type of investment over the long haul. Leave the stock-picking to the pros and simplify your investment strategy with a mutual fund or two. Mutual funds cover a wide variety of investment styles, with different risk levels and expected gains. Investing in mutual funds can be easy. After you buy into a fund, which may have a minimum initial investment of a couple thousand dollars, you can set up automatic investments for as little as a hundred dollars a month.

Before you invest, be sure to have a nice chunk of savings that is easily accessible for emergency needs. The stock market does fluctuate, and you don't want to be forced to cash in your shares when the market takes a dip. You don't lose any money in a bad market unless you sell in a bad market, so be prepared to hang on to a sound investment until it rebounds.

I hope you now realize that there are better ways to save than through overpaying your income tax. Reduce the amount of income tax withholding so you can put that money to good use all year. Fill out a new W-4 form with your employer, and adjust the number of personal allowances to have less income tax withheld.

You can update your W-4 at any time during your employment, and at any time during the year. The earlier in the year, the better, so that you can have a more accurate withholding that reflects your actual tax bill. If you don't get around to it until later in the year, after way too much has already been withheld, you can increase your allowances a little more to make up for it.

As long as the IRS gets it all by April 15th of the next year, they don't care if you paid all of it in the first half and none of it in the second half of the year.

Just make sure that you fill out another W-4 at the start of the next year so that you don't have too little withheld. It's important that you have enough tax withheld; you could be hit with a tax underpayment penalty and charged interest if you owe more than 10% of your total tax bill, or $1000 when you file.

Isn't it funny how they don't pay you a dime extra if they hold on to a massive tax overpayment for a year, but if you dare hold out on them, you will be charged for it? That's just another point to prove that the IRS is not who you want in charge of saving your money for you. Maybe you could turn the tables on the IRS...

You can adjust your tax withholding so that you owe just a little at tax time, as long as it is under the amount you'd be penalized for. Make sure that you save enough throughout the year so that the tax payment is not a burden on you. If you owe anything, wait until closer to the April 15th deadline to file and send payment. Why pay something in February when you can keep your money working for you until April? In effect, the IRS will be giving you an interest-free loan. Where else can you get a deal like that?
Say "No" to the Tax Refund Anticipation ...
Make Good Use of Your Income Tax Refund


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Friday, 23 February 2024

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