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Tax Refunds: Free Loan to the Government or Forced Savings?
It’s that time of year again here in the USA – tax season! I finally completed and submitted my tax returns (federal and state) early yesterday morning. I’ve found TurboTax to be fairly straightforward to use (at least for the Federal) so I’ve done them myself for as long as I’ve done them (I’ve tried TaxCut too but prefer TurboTax). It has handled my returns sufficiently as they’ve grown in complexity (this year I have Schedules A, B, C, D, H, SE, and Form 2441). With my side business growing, however, I am definitely considering turning it over to a pro next year….we’ll see.
Side note about using TurboTax: as most of you know, you put all your income in first before adding your deductions. For us, that leads to TurboTax telling me that we owe this enormous amount of money! Then I view it as a challenge to whittle it down and I get real excited as it gets closer to $0. But it’s a bit unnerving to look up and see that you owe the federal government alone almost $10,000! (last year, I think it peaked for us near $15,000!).
Anyway, I’m getting a pretty good chunk of change back from my federal and state governments this year and I find it interesting to see how different people react to the idea of getting a tax refund.
Woohoo – free money from the government
In this corner there is the group of people who consider their tax refund to be a windfall from the government. It’s found money or an April Bonus. If you fall into this camp, remember that this is your money ! This is not our generous government giving you some money for the fun of it (that’s called a stimulus check). You have basically allowed the government to borrow your money (kinda like your deadbeat uncle) for about a year with no interest (Unlike your uncle, however, if you actually ask nicely by filling out the correct forms the government will give it back to you). But it’s not a gift or a bonus!
A splinter group of this camp is the people who might view a tax refund as forced savings. If they had received the extra money in each paycheck, it probably would have evaporated into the ether by now. By overpaying the government, at least they were able to end up with some money come April.
A 0% interest loan
As I mentioned above, the other group considers a tax refund to be a wasted opportunity. This money has an opportunity cost of the lost interest they could have earned throughout the year. This is a mathematically accurate way to look at a tax refund, but as Dave Ramsey likes to say to his listeners (I’m paraphrasing), "Don’t talk to me about math, if you were good at math, you wouldn’t have all this debt to begin with."
If you want to talk about math, the optimal strategy is to underpay as much as possible (just remember there is a penalty if you go too low). This will leave you with a large tax bill, but the maximum amount of your money will have been working for you throughout the year. Writing a huge check to the government is easier said then done, however (Personally, I think I’d like to shoot for being pretty close to $0).
If you are good about automating your saving and investing, then a large tax refund is a certainly a less-than-idea situation. If you can put that money to work for you throughout the year, you’ll end up with more money (in the long-term) than you would have by allowing the government to sit on it and give it back each spring. If you are not good about controlling your money, however, then this strategy will just lead to more squandered money and you might be better off having the government save it for you.
My thoughts on a large refund this year
I guess I get freaked out about underpaying my taxes so I am reluctant to decrease my withholding. I did decrease it a bit last year, but with starting a tiny side business, I was wary of decreasing it too much. And I’ll chicken out and do the same thing this year because I am foreseeing an increase in my extra income. So, I’m left annoyed that I’m letting the government sit on so much of my money each year.
On the other hand, If I had the money during this particular year, I would have maybe put some into the stock market (and would have much less of it now) or I could have put it into a savings account and earned 2% interest or less. So, taking into account that possible 2% gain at best (reduced further by taxes), I am trying to tell myself not to feel bad about the refund this year.
Besides, we made it through the year in good shape for our finances, so I won’t be complaining when I get the money deposited into my bank account. I’ll take the money, put it into my emergency and vacation funds, and start trying to convince myself to decrease my withholding again this year.
What are your thoughts on your income taxes? Do you like to get a large refund? Do you like to pay a little bit?
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5 Responses to “Tax Refunds: Free Loan to the Government or Forced Savings?”
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I used Turbotax last year and I think we ended up getting back a couple hundred dollars. I felt pretty good knowing we kept it pretty close. However this year I claimed 2 and my wife claimed 0 and Turbotax has us owing around $900. While we have the money to cover it, I’m not thrilled about it. I’m planning on going to a tax expert to see if he can help.
On a side not, its hard not to be envious of all those people getting thousands of dollars back. I realize it’s there money, but it’s still hard to hear.
You’re right- that tax refund IS your money after all! I use Turbo tax myself, and it works well for me.
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Wife likes refunds and I hate them. My goal is to have to pay the maximum with out incurring a pentalty. However that stresses her out so we compromise. Around September plug your year to date numbers in your tax program and see how close your are.
@Travis – I can see how it is frustrating. It’s always a nice feeling to get money back. Maybe it’s not the greatest thing to be over-withholding and getting less take home pay throughout the year, but by tax time that’s all in the past and I want some money right now! That’s how I felt this year. I’ve already put my refunds into my emergency fund, though, so I am not treating it like I won a prize or something and blowing it on something I don’t need.
@GHolmes – Financially speaking that does make the most sense, at the same time, it’s still hard to write a big check each spring and I can see why it would stress your wife out!
You kinow, I think that it is even worth having someone else do your taxes because the money is so important. Especially if you run your own business.