In the past, I received tax refunds I otherwise wouldn’t have expected. I exuded an appropriate level of joyfulness.
For example, a single guy might work for only one employer, receive one W-2 form, and won’t have much non-withheld income. He will probably receive a small refund. Or a family receives two W-2 forms and, because they didn’t calculate their withholding correctly, they’ll receive a large refund. Cue cheers of joy!
Except, the federal government should be the one celebrating. They’ve been using “your” money — money belonging to those of us who are due a refund — for free! Usually, when you lend money to someone, you charge interest to compensate yourself for its use. Why would you give the government, an organization that will use your money in ways you may not approve, a free ride?
It’s because this creates “forced savings.” By having more money than necessary withdrawn from each paycheck, you are automatically putting some money aside for later.
Even if your return arrives lightning quick and without problem, it’s still a ridiculous situation. But, most of us stand for it, year after year. Why don’t we break the cycle of free loans to the government, then strange joy when our money is returned?
Let’s start with the typical rationale. Here’s why “forced savings” isn't a very good excuse.
You are not earning interest. In a high-yield bank account like Barclays, the money could earn interest. If you hand excess money to the government each pay period, the government gets to keep any interest it could be earning. You might as well throw money out the window.
You don’t have use of the money. . You could have used that money to pay off your debt, repair your house, or invest for your retirement. Perhaps instead you relied on a credit card temporarily and ran up interest charges.
Saving yourself isn’t difficult. Don’t rely on the government for a savings plan. You can automatically transfer a portion of your paycheck into a savings account, and not even think about it (essentially, the same thing you’re already doing). When you re-calculate your withholding and change the form with your employer, set up direct deposit so you receive your pay directly in your bank account. Then, set up an automated recurring transfer to move a portion of your pay into a savings account that’s earning interest.
It’s easy to use up your refund fast. Receiving a large check from the government encourages people to make unnecessary or unplanned purchases. While that might be great for the economy in general, you might be making choices you wouldn’t have been if that money was spread out over the course of the year. If it were incorporated into your weekly or biweekly income, you would be more apt to budget it wisely.
In fact, you should consider planning your withholding so you owe the government when you file your taxes. I know what you're thinking, "Who the heck would want to owe the government money?" In this scenario, all the drawbacks mentioned above become your advantages. You’ve had access to government money throughout the year. As long as you stay within limits, you won’t owe the government any interest or fees. You can earn interest or invest the government’s money, tucking that cash into an interest bearing account, ready to pay your tax bill when it comes due.
For many it simply may be a psychological issue. The same way that people tackle debt differently using various methods, you have to find what is right for you. There just seems to be something uneasy about writing a check or paying a large tax bill to the government come April. There is a feeling of joy that does simply come from getting a check back at the end of the year, even if it is your own money. So the best option is to take into consideration the reasons above for you to plan ahead and manage your money so you are prepared come tax time.
Of course, be sure to keep track of approximately how much you’ll owe, and don't put yourself in a situation where you cannot pay your tax bill by the deadline in April. If you’re going to avoid a tax refund, you need to be smart and not create a bigger issue.