Many of us like to get a big tax refund each year when we file our returns. In fact, the IRS reported that as of March 4, the average refund so far in 2022 was $3,401. It can be fun to get a few thousand dollars deposited into your account, but is that large refund actually a good thing? Let’s explore the pros and cons.
Pros of a tax refund
- It helps you save money. Getting a large refund can be useful for padding your savings—if you spend or invest the check responsibly. If you struggle with putting money aside from your paycheck for your savings each month, it may be useful to allow that money to be withheld. Just be sure to invest the refund amount or put it into your savings, if this is your goal! Think of that money as what you’ve saved, not a bonus check.
- It can help pay off debt. A LendingTree Survey found that 37% of Americans plan to use their tax refund to pay off debts. This can be a great opportunity to pay off a chunk of debt—whether it’s student loans, credit cards, or other debts you may have.
- It helps prevent unexpected balances due. If you’re not doing careful tax planning and working with an accountant or tax preparer throughout the year, you may not be prepared for a significant balance due in April. Withholding more than you need to can help you not have to worry about paying a balance due later.
Cons of a tax refund
- You get less each pay period. This may seem obvious, but remember that your regular bills typically occur each month, not once a year in April. If you sometimes find yourself struggling with regular expenses and or even just want a little extra spending money each month, it may be more useful to adjust your withholding to have that tax money back in your paycheck rather than getting a large refund.
- It can encourage impulse spending. While it’s true that a tax refund can be useful for saving or paying off debts—and many people do use it this way—it’s also true that it can be tempting to spend it quickly. If you find yourself prone to impulse spending when presented with a large check, it may be better to reduce your withholding so you can spread that money out through the year and better track your spending.
- It’s not a gift. It’s an interest free loan. Tax refund checks often feel like a bonus, but it’s really just money you’ve already earned. You pay for that refund the other 11 months of the year by withholding more than you need to from your paycheck. The IRS then returns you only what you’re owed. Your money isn’t earning interest being held by the IRS in the way that it might if you invested those funds instead.
It’s not necessarily right or wrong for you to be receiving a refund, as a lot depends on you and your situation. There are some pros, but there are other ways to achieve those same benefits.
If you struggle with putting aside money for savings, you can set up an automatic transfer to put money into your savings account or investment accounts when you get your paychecks. Making regular payments toward your debts may help you reduce interest or avoid carrying a balance on your credit cards. You can adjust your withholdings and plan for any payments by working with a tax professional during the year, so you’re ready for tax time.
If you need help deciding what to do with a refund check, adjusting your withholding, or just figuring out whether a refund is right for you, Padgett is here. Our nationwide network of EAs and CPAs can work with you all year round to help improve your financial situation. Find an office near you today!