By Douglas A. Boneparth, CFP®, AIF®, MBA
For the majority of people, a tax refund is something they look forward to receiving. However, financial advisors do not celebrate the fact most people receive a tax refund, because it means they just loaned the government money interest-free by having too much money withheld from their paychecks for taxes throughout the year.
According to a Bankrate Money Pulse poll, more than half of Americans would prefer to get a refund than break even or owe the IRS money, with only 27% wanting to not owe any money and not get a refund. One theory why most Americans want to receive a tax refund is because they do not manage their savings well the rest of the year.
Poor Cash Management
If the government is holding your money, you can’t touch it. There is no way for you to book that Caribbean vacation or buy that new red Mazda Miata. But putting the government in charge of your savings is not smart cash management. This constitutes a lack of planning, and from a financial perspective, it is not the way anyone should be saving money.
It's inevitable that some of you will receive a tax refund, but you can be smart about what you do with it. You can use your tax refund to pay down debt, add it to savings or invest it. Or you may decide to spend it on necessities such as groceries or utility bills.
While using your tax refund to pay down your debt is a smart financial decision, paying down your debt throughout the rest of the year is important too. Waiting for your refund to pay down debt allows the interest charges on your debt will grow. And there is a possibility you will not receive as large of a refund as you were expecting or there will be a delay in receiving it from the IRS, which will make it that much harder to pay off your debt. (For more, see: Prioritizing Debt.)
Don't Let the Government Decide What to Do With Your Money
Before you set your annual deductions so you will receive a refund, you should:
- Evaluate your own financial situation.
- Research the trade-offs between receiving a tax refund and not receiving one.
- Work with a qualified professional like a CPA to determine what other tax planning strategies might be beneficial to you.
The ideal situation for most people is to receive no refund and owe no taxes, so you aren't letting the government control your savings and you don't end up with a big tax bill. But that can be difficult to accomplish because taxes are complicated. That's why working with an expert to find the right balance can pay off in the long run.
(For more from this author, see: 5 Tips for Boomerang Millennials.)
This article was originally published on Investopedia.