“I’m getting a big refund from the IRS this year, which is great. But free money from the government seems too good to be true. Am I doing something wrong?”
The short answer—you are not doing anything wrong, but free money from the government really isn’t free. It is your money, to begin with. It seems we have a mindset these days that it is necessary to get a big tax refund. It is not, and in fact, big tax refunds could be hurting you financially.
Sure, it feels great to get a big tax refund and is definitely better than owing money. However, a tax refund is one of the worst “investments” you can make with your money and the eagerness of getting your refund doesn’t equate to the fact that you could do better things with it.
Don’t forget, the IRS isn’t paying you interest. If you lower you’re withholding and put that money into a savings or money market account, you’ll get a better return because you’ll be putting your money to work for you. Sure rates aren’t that high right now, but tax refunds contain earn zero interest.
If an emergency comes up during the year, you can’t use any money the IRS is withholding. What happens if you need cash in August to repair the home our car? Or money in December to buy gifts? You’ll need to dip into savings, and if you don’t have enough on hand, you may have to take a loan or rack up credit card debt. This actually happened to me a couple of years ago when I had a major household emergency. Wouldn’t you rather just have that cash on hand in our a money market account? Then you won’t end up paying interest on your credit card debt while the IRS holds your cash for you.
I split my refund money a number of different ways, but one thing I do is use part of it toward my summer vacation. Maybe you want to plan a vacation for next year. If you are anticipating a refund, it is hard to plan until you figure out exactly where you stand. By having more money in your paycheck each pay period, you can start a Vacation Club account here at the Credit Union and save consistently.
As I write this, I just finished filing my taxes. I definitely have plans for this money—reduce credit card debt, plan a vacation, and continue to fix up my home. I’ll get a nice thrill when the federal refund is direct deposited into my account. It’s a lot bigger than the days I was a single guy living in an apartment in Stratford, Connecticut (family deductions help), but maybe I’m still withholding like I’m the person I once was. Perhaps it is time to consider reducing my own refund and living a little more during the year.
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Recently, I read a column where someone asked: