It's that time of year again that most people dread: tax season. If you're like many Americans, you're probably planning on a tax refund. Even though that boost of money feels good at the time, it's actually better to not receive a refund. When your taxes are withheld during the year, you could be missing out on some of the money you earned.
How a tax refund works
Throughout the year, people pay federal and state income taxes from their own paycheck. A tax refund is the result of overpaying these taxes. That means your giving away your money during the year just to get a chunk back during tax season. If you maximize the money you are getting each pay period, you won't have a big tax refund every year. And that's good!
A National Foundation for Credit Counseling (NFCC) online poll revealed that a strong majority of respondents intentionally plan to receive a federal income tax refund.
“The findings suggest that receiving an income tax refund has become standard operating procedure for some people,” said Gail Cunningham, spokesperson for the NFCC.
People may argue that overpaying Uncle Sam each pay period is the only way they can save, as their withholding has become a method of forced savings. If you really look at it, that reasoning is outweighed by the many benefits of having an accurate amount withheld from your paycheck.
Benefits of not getting a tax refund
Financial professionals at The Village Family Service Center share 10 reasons it's actually better to not have a federal income tax refund:
1. Overpaying any financial obligation rarely makes sense. No one wants to end up owing more taxes than they are prepared to pay, but receiving a big tax refund is not the best solution.
2. Intentionally choosing to loan money without the benefit of earning interest isn’t a smart use of money.
3. If saving is the objective, there are better options to meet that goal.
4. Not having ready access to one’s own money could put a person in financial jeopardy if an unplanned expense or emergency occurs.
5. Having less money throughout the year could add the burden of financial stress.
6. A lower paycheck could result in charging items that otherwise would have been paid for with cash, thus potentially creating debt.
7. Less money available for debt repayment could increase the likelihood of late payments, resulting in a negative impact on your credit report and score.
8. A smaller paycheck diminishes the opportunity to save, pay bills, donate, or invest.
9. In spite of good intentions, a once-per-year refund often results in a once-per-year splurge.
10.The solution is an easy fix.
“Often the very people who celebrate receiving a refund are those who are most in need of extra money in their pocket each month,” explained Cunningham.
Living paycheck-to-paycheck can cause people to fall behind on important priorities such as rent or vehicle payments. The good news is that there is a way to control your finances during the year, as well as your tax refund.
How to control your withholding
To calculate the proper number of withholding allowances, go to www.IRS.gov. Type “withholding calculator” into the search bar. After determining the number of allowances, complete a new W-4 if necessary. Workers are allowed to submit an updated W-4 to their employer at any time during the year.
Pro Tip: If the adjusted allowances result in a higher paycheck, decide how to best allocate the extra money. Cunningham notes that without a solid plan to execute against, the money will likely not serve its intended purpose. Whether your objective is to save, catch up on bills, donate to charity, or invest, it will help to make a plan.
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*Originally published March 2014