Tax Refunds: Does Size Matter?
Taxes have been filed, and a refund has arrived in the MyMoneyMinute household to the tune of about $360. Last year, we were hit with about a $2,000 tax bill, so I was pleasantly surprised to end up on the receiving side this time around… but should I be?
Money Experts: “You Don’t Want A Big Refund!”
Many financial experts, including Dave Ramsey, frown upon a big tax refund. Why? Because the money you’re getting back was yours in the first place — it’s just been held hostage by the government for a year, interest free! The solution for them is to adjust your income tax withholding on your paycheck so that you receive more money each pay period. Additionally, if you receive a larger lump-sum return, you’re more likely to spend it on a big-ticket item (electronics, vacation, etc.) rather than use it in a more financially responsible way, like paying off a car loan or credit cards, building up an emergency fund, or even for extra giving to your local church ministries.
For more on this argument, read articles by these two great bloggers:
Craig Ford from Bible Money Matters – 3 Reasons Why A Big Income Tax Refund Is A Horrible Thing.
Jason Price from One Money Design — Income Tax Refund: Is It Good Or Bad?
Me: “It’s Not So Cut & Dry”
In an ideal world, I agree with the guys above. Unfortunately we don’t live in an ideal world. If I lived in an ideal world, I’d never owe taxes or get a refund. Then again, I also would never have charged money on a credit card, financed my life (cars, furniture, a home, and an education that cost even more than the home!). Oh, and I’d have a stable job, an ideal salary, with predictable raises and bonuses too.
The 2 Major Reasons To Tolerate A Big Tax Refund
While aspiring for the ideal scenario above, there are reasons a big tax refund isn’t such a horrible thing after all. Here are a few of them:
1. You Suck With Money
Let’s face it. If, instead of getting a big chunk of money in a refund each year, you got monthly slices of it by altering your withholding, it is almost guaranteed that money would be spent, and you wouldn’t even know where it went. A few extra bucks each paycheck would be swallowed up by a restaurant here and a Starbucks trip there. When you get one big check after tax season each year, you only have to make one financial choice each year, not 12 monthly choices to do the financially smart thing. And hey, even if you make the wrong choice and blow the entire refund, at least you’ll get a really cool big-ticket item out of the deal, rather than spending it all throughout the year and not knowing where it went. If you’re gonna be stupid with your money, at least get a TV or an all-inclusive vacation to show for it.
The majority of us are financially undisciplined. Until you get disciplined, a big refund can protect you from… you. For a great analogy of this argument, check out an article written by Sam at Financial Samurai — Tax Refunds Are Good For Most People, Because Most People Can’t Save.
2. The Danger of “Normal”: Risk Is Diminished
What my blogging friends didn’t discuss in this tax debate was this: we face problems adjusting our income withholdings because life is rarely “normal” or “ideal”. Most people I know with a “stable” salary and tax structure are government employees. In this economic climate, even those jobs aren’t safe. People are underemployed and laid off in record numbers to the point where it is difficult to determine what your expected yearly withholdings should be. Additionally, life happens too — you get married, buy a house, have children, buy a different house, someone gets injured on the job or gets pregnant — all these life changes affect your taxes, which means your withholdings may be off again.
For me, a limited return is ideal, but does not factor in the reality of risk. From a risk standpoint, I’d much rather risk (1) giving the government my money interest-free for a year and get a big refund, rather than (2) miscalculate my withholdings and having to scramble to come up with an unexpected tax bill.
Conclusion
Currently, my life is just not stable enough to justify the risk of accidentally under-withholding to the point where I owe a big tax bill, and I suspect most people are in the same boat. Perhaps down the road, life is a bit more stable and less in flux, I can spend the extra energy to get my withholdings down to a science. But until then, I’ll err on the side of caution.
What Say You?
Don’t forget to read the articles by Craig, Jason, and Sam – then drop a comment below and let me know how you deal with your income withholding & tax refunds.
I think a $360 refund is great. I personally think the closest you can get to $0 is the goal. I’m always happy with a small + or – either way. You aren’t going to earn a ton of interest on a $360 deposit which is spread across a whole year, nor is it going to be too hard to find the money if you have to pay.
P.G.,
Yeah, I think $360 is a pretty good estimation. I guess even if we owed that much it wouldn’t kill me, but I hate having to come up with extra money that I didn’t plan to spend. I’d much rather be on the positive side and I gather most people would too.
Even if my refund was say, $2,000, the interest lost because you over-withheld and the gov’t had your money interest-free amounts to about the cost of a sit-down dinner (without margaritas!). I say it’s worth it to err on the side of caution and sacrifice the extra meal money, rather than spend $2,000 over the course of the year and not know where it went — especially if your family income isn’t stable.
Awesome comments, keep ‘em coming!
The problem might be that the same people that “suck with money” are probably the same people with high interest debt. They give the government this interest free loan of upwards of thousands of dollars and also accumulate credit card debt at 20% interest. It’s a double whammy. I do agree with you, in that it’s definitely better to get a few hundred dollars back. As long as it is kept to a few hundred rather than thousands of dollars then it’s no big deal to get a refund.
Great point. The double-whammy hits those struggling the hardest. It is certainly better to have a refund closer to zero rather than thousands, especially when there’s likely high-interest credit card debt looming out there unpaid. Then again, it’s unlikely the extra money each paycheck would go to pay off that debt. If the discipline isn’t there each month to pay down a card at 20% interest, then maybe it’s worth taking the hit all year & hope the right decision is made with a big tax return.
I suppose for these reasons I lean toward Financial Samurai’s cookie analogy in his post. You are protecting you from yourself, which most people need.
Great observation; keep ‘em coming!
I’ll take the smallest refund I can get. I do not like the government enjoying the use of my money tax free. Still one wants to avoid penalties for under withholding. Make sure you pay at least 90% of your tax bill during the year.
Sounds like you might be well-disciplined with your finances, so the closer you can get to zero, the better.
I unintentionallyended up with a large refund this year.
About 30% or more of my income was paid (wrongly, but there wasn’t anything I could do about it) as contractor income, and another significant portion was unpredictable due to overtime. I’d underestimated my tax bill the year prior and had to pay about $1200 in additional taxes plus a substantial fee so I increased my withholdings for tax year 2009.
Then our offices were shut down with 30 day official advance notice mid-2009. Though I had suspected we were facing the layoff, I didn’t know how much to expect in the way of payouts, so I just left well enough alone. The fee was high enough that I’d rather sacrifice several months’ worth of insignificant interest to make sure I wasn’t going to be penalized again.
*shrug* It’s not the best thing in the world but like Daddy Paul notes, better to avoid penalties for under withholding.
I take the smallest refund I can get, I don’t like lending my money out to the government at no interest. On the other hand I understand the argument of having a tax refund be a forced saving plan. However, I think that for those that think that way, way too many of them end up just spending their refund on luxury items anyway, instead of saving it or paying off debt.
Agreed, better to overwithhold. Sorry about the 1099/W-2 problem – I hear that’s prevalent with businesses in the bad economy.
Good point – if your bad with money all year, the likelihood of you being responsible with a big refund is probably pretty low. But for bad money managers, I may lean towards a big refund with that risk, rather than that same person end up owing the government money, and falling further behind.
Thanks for the comment!