The problem with that large tax refund
By Jennifer Goforth Gregory
I excitedly told my father that I was getting a large tax refund, expecting him to be as happy as I was. I was 22 years old. I had been working at my first professional job for less than a year and struggling each month to pay rent. To me, the $4,500 IRS check headed my way was the equivalent of winning the Powerball lottery.
But instead of being happy for my windfall, my father, who has worked his entire career in the financial and banking industries, gave me a gentle but firm lecture about how I had given the government an interest-free loan on my money.
Who doesn't like lump-sum payments?
I was not alone in my joy over a large refund. According to a March poll from the National Foundation for Credit Counseling (NFCC), 58 percent of people intentionally receive an income tax refund instead of keeping a larger portion of their take-home pay throughout the year. But as my dad so wisely pointed out, this really isn't the best financial move.
Instead of saving my large refund, I ended up spending it on a vacation. Had I made wiser tax elections, the extra money I would have received throughout the year could have made the difference between comfortably paying my bills and the sleepless nights I spent worrying about money.
While the beginning of the year is the ideal time to make adjustments to your withholding, many people don't realize that their current withholding are netting a large refund until tax time. But making modifications in March or April still can help you increase the amount of money you have throughout the year and decrease the amount you are lending to the government in 2013.
The NFCC offers the following tips for those who received a refund for the 2012 tax year:
- Use your 2012 tax refund to boost your emergency fund. Make sure that the money is in an interest-bearing vehicle, such as a savings account or CD. Unless you have an overflowing emergency fund and all of your debt is paid, resist the urge to head to the mall or buy a plane ticket.
- Calculate your proper amount of W-4 withholding allowances. Use the IRS Withholding Calculator to determine the right amount for your situation. Make modifications to your withholding with your employer and encourage your spouse to do the same. If you have any life events during the year, such as a birth, death or divorce, update your withholding with your employer.
- Determine a plan for responsibly using the extra money you will have in your paycheck each month. If you simply use the cash to increase the entertainment portion of your budget or buy the latest fashions, then you are missing an opportunity to move closer to meeting your financial goals. Paying bills, paying off credit cards and establishing the ever-important emergency fund are all great uses for the extra income.
So if you find yourself getting a refund of more than a couple hundred dollars from the IRS this year, take a few minutes to evaluate your tax strategy for next year. Instead of getting a large refund as I did many years ago, I have a very small check coming my way this spring. I think I will give my dad a call. He will be proud.