**Disclaimer: This does not constitute as tax advice. Please seek out a licensed accountant or financial adviser for information on tax related questions.**
Although receiving a tax refund may feel like a bonus, it’s really not. So where does this money come from? Each year you set your withholding amount, this is the amount of tax that you would like the government to take out of your paycheck. If you set the withholding amount to high the government ends up taking more out of your check than they needed to pay your taxes. This extra money is then returned to you in the form of a tax refund. So really you were just letting the government hold a little bit of each paycheck and then give it to you all at once. There can be advantages and disadvantages to this. First, let’s consider the advantages of receiving a large tax refund.
Receiving a lump sum is always nice. It allows you to go on that vacation, catch up on bills or simply invest it toward a project. By allowing it to come out of our check automatically we are forced to save it and not touch it. This can be a great way if you are struggling to save money. Another advantage is that you do not have to worry about facing a tax bill at the end of the tax season.
While this sounds like a great idea, there are also some disadvantages. Below are some of the disadvantages of receiving a large tax refund.
Ever heard the saying “Money now is worth more than money tomorrow”? This saying leads to one of the major disadvantages. By having a tax refund you sacrificed the opportunity to use that money throughout the year. That money was worth more when it was taken out of your paycheck due to inflation. Inflation means that over time the value of the dollar decreases, so you cannot purchase as much with it when you receive your refund as you could have along the way.
While receiving a tax return is neither good nor bad in any situation there are other ideas. Below are a few ideas to consider for next year.
Adjust Your Withholding
Adjusting your withholding can allow you more room in your monthly budget. If you are worried that extra money may get washed away in the day to day expenses, set up an account and set an automatic contribution to it. This could be a savings account, investment account, ext. By doing this you can have your money work for you in the form of interest earnings.
Have a Plan for Your Refund
Before your check comes in the mail, take time to write out a plan for how you will use the money. Whether it’s for one of the ideas mentioned above or another use, have a plan. The more specific your plan is the better.
Invest Your Refund
It is important to prepare for the future. It is easy to put this lower on the priority list because the future does not affect us now. If you find yourself doing this, maybe using your refund to catch up on investing is a good idea. Be sure to evaluate your goals and make educated investment decisions if this is what you decide to do with your refund.
Peer Financial Counselor II