Is a big tax refund a good thing?

Sometimes, financial planner types like myself get focused on “perfect” solutions that either rely on precise numbers, or are elegant in theory but might not be that beneficial in practice.  For instance, people like me get pretty excited about the ability to earn 1%+ on a savings account when the big banks are typically paying .1%-.2%.  So, if you’ve got $10,000 in a savings account, you stand to gain an extra $100 every year.  It’s always handy to have extra money, but that is probably not going to be the most impactful change you’ll make while changing your financial life.

Similarly, some of us hold dearly to the idea that we shouldn’t “lend” the government money by having more taxes withheld from our paychecks than is absolutely necessary.  In other words, don’t get a big tax refund.

Is a big tax refund a good thing?

To be clear, I’m not a big fan of getting a big tax refund.  However, as a recent USA Today Money article points out, getting a big check every April may be okay for some people, and I think there is always merit to exploring a topic from an angle that runs counter to our own position.  The article suggests that there are 5 reasons why it might make sense.  Getting a big refund can:

  • Help to avoid a debt trap – Owing taxes that you’re not prepared to pay can cause a much more significant problem than any benefit received by not paying the requisite amount throughout the year.
  • Provide a welcome windfall – For taxpayers who are not prone to saving, a big tax refund may be one of the few ways to accumulate funds.  Of course, if they turn around and spend it frivolously, the benefit disappears.
  • Protect against tax surprises – Circumstances change throughout the year.  Let’s say an emergency occurs, and you withdraw some funds from your IRA that you didn’t anticipate withdrawing.  Since you’re probably not sure exactly where you stand from a tax perspective at the point of withdrawal, having extra funds withheld may provide a reasonable buffer to provide some protection.  If no emergenices arise, you enjoy the “windfall” that comes with a larger refund.
  • Force savings –  This very much goes hand-in-hand with the windfall benefit.  Instead of saving throughout the year, taxpayers who are not savers can use a healthy refund to fund expenditures for which they would otherwise need to save.  I think this is probably the biggest reason that people deliberately choose to get a big refund.
  • Cost little in lost opportunities – I think this is the best argument for getting a sizable return.  In the article’s example, a taxpayer who sets aside $2,400 over the course of the year and puts it in a savings account with a rate of .25% would gain $6 before taxes.  And .25% may be more ample than many taxpayers are earning.  On the other hand, if the funds are sizable and can be invested productively, this argument gets weaker.  It is also pretty unique to the current interest rate environment.  In January, 1982, when the average 3-month CD rate was over 15%, the lost opportunity was anything but little.

Food for thought.  Do you like to get a big refund?

About Kevin O'Reilly, CFP®

Kevin O'Reilly, CFP®, is a financial advisor who specializes in working with parents of twins and triplets. Have a financial question? Ask Kevin!

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