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Tax Refunds: Why Smaller is Better

Some people do a little victory dance when that tax refund check comes in the mail. But truth is, in the long run there’s nothing really to celebrate.

"Getting a refund check for $5,000 or more each year is like an addictive habit for some people. They get a rush from a big check arriving in the mail like they hit the lottery. Unfortunately, it’s just their own money they are getting back," says Jon Ulin, founder and managing partner of Ulin & Co. Wealth Management.

"We advise our clients to pay in only enough in federal income taxes from their paychecks throughout the year to come as close to breaking even on their federal income tax liability as possible. Do not overpay your federal taxes," says Ulin.

At the end of the year, if you’re a bit short on your federal income tax obligation, you simply just send a check to the IRS. If you’re getting more than $1,000 back in refunds from the IRS, then this proverb applies to you, "To Uncle Sam, you will neither a borrower nor a lender," says Ulin.

when you get a refund, it means you gave the IRS an interest-free loan for the year

Maybe you convince yourself that the refund money will be used to pay for a vacation, knock off some debt, or make house or car repairs. But when you get a refund, it means you gave the IRS an interest-free loan for the year. "Anyone else, even a bank, would pay you interest on the money. But not the IRS, it returns only the amount you overpaid, regardless of how much money you gave or how long you ‘loaned’ them the money," says Richard Reyes, a certified financial planner with Wealth & Business Planning Group.

Short-term gain can mean long-term regret

Your money being held by the IRS is not liquid. If you have a job loss or personal emergency, you can’t just call up the IRS and ask them to send you your money when need it most.

Instead of giving Uncle Sam a loan, you could be investing that money or paying bills. Take for example, if you have a credit card debt charging you 18% per year, you would save yourself $900 in interest payments by paying off your debt, rather than overpaying your federal income taxes, says Ulin.

Then too, if you defer less in federal income taxes and put your money to work in a before tax retirement account, such as your employer sponsored 401(k), you could end up saving a decent amount of money in federal income taxes based on your personal blended tax rate, adds Ulin.

How to get your withholding right

Estimate how much in federal income taxes you will owe for the year and then divide that amount by the number of paychecks you expect for the year. If your income and deductions do not change much from year to year, you can simply look at what you owed in federal taxes for last year and allocate the same amount for this year but increased for inflation if your income is adjusted up as well, says Ulin.

Most people pay the bulk of their annual tax bills through payroll withholdings. Through this process, a percentage of your pay is taken out each pay period and sent to the IRS where it is credited toward your final tax bill. Review your employer W-4 withholdings at least once a year. Many circumstances can affect the amount of tax you’ll eventually owe, says Ulin.

The IRS has a withholding a calculator that can help you figure out how much should be taken out. However, "Most times it will still have you withholding too much. My bias is to work with a professional to get it within the right range," says Chris Hardy, managing director of Paramount Tax and Accounting.

Also, once you complete the withholding calculator and you find that you are between exemptions, you can choose a lesser exemption amount and add a flat dollar amount on line 6 of the W-4 before turning it in to your employer.

If you’re getting substantial refunds each year, talk to a tax professional to make sure you’re claiming all the exemptions you can.

"I recommend that you increase the number of exemptions you claim by 1 for every $2,000 of tax refund you get back. Then when your deductions change, take the extra money and put part of it in a savings or investment account. At the end of the year, you will still have the money and you will have earned interest on it," says attorney Edrie Pfeiffer, an attorney with Hampton Roads Legal Services.

Another source of help, says Jayson Mullin, CEO of Top Tax Defenders is the IRS’ "lock in" department at 855-839-2235. "They may be able to walk you through how many allowances you should be able to take. If the agent is wiling, they can access your past year tax returns and use this information to calculate a reliable allowance amount."

Finally, points out Hardy, "The majority of people focus on preparing their tax return, not tax planning. Tax planning is where you can get the biggest ROI for your money. April 1 is not the time to be tax planning for the prior year."

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51hh   |     |   Comment #1
My tax refund (which usually is a large sum) go toward my Roth IRA contribution for the same year.
Anonymous   |     |   Comment #2
Came close. $157 refund for 2014.
Anonymous   |     |   Comment #3
Does anyone know what will happened tomorrow? and at worst you want to owe anything to the IRS. I rather have a refund at the end of the is why, firstly if I pay more into taxes, esp for those with low income, I can budget myself and at the end of the year I don't ow nothing to the IRS and can also get a refund which I might be able to use for something better. 2nd If I had a change of job, which I would earn more money, and the exemption was 1 or 2, that would have me have a negative balance with IRS because now I wouldn't be paying enough. how about you had two jobs, and each job you made 25K and you had selected on exemption on your W4? The first job would assume, you got one exemption, and so did the 2nd job....thus you'll owe more money to the IRS at the end of the year. 
Anonymous   |     |   Comment #4
Agreed.  There is nothing wrong with maintaining a bit of a cushion, provided the cushion is not excessively large.  Also, maintaining a cushion at a time like this, when interest rates are so very low, is not especially costly.  If interest rates were over 6% I would probably be singing a different tune.  ;-)
Anonymous   |     |   Comment #5
Some people think a LARGE refund is a good way to save. A refund is the "amount you overpaid"  It's best to get a small refund or even owe a little.  Your giving the gov't an interest  free loan.  Might as well pull the money out of your paycheck and invest it or put it in a savings account.  If you owe some at the end of the year it's in the savings account and you can write a check on the 15th.  My wife works in New Jersey and we live in NY.  I submit my NJ taxes the 1st week of April, NJ does not give us our refund until September.  Last year they "lost" my return and I had to wait till November to get the refund (We try to keep the amount small).  As with financial decisions you have to make the choices you are comfortable with.
Anonymous   |     |   Comment #6
No refund but owing owing the maximum allowable amount is always my goal.  But for someone that stays in debt most of the time and has a hard time dealing with their finances, then having a refund would be better than owing the IRS and not having the funds to pay the owed taxes.  This is no way to be, but I think I have some relatives that would be in this shape if they did not pay enough to get a refund .  In this case, a refund would be better than them calling me for a loan to payoff the IRS.  A loan that most likely would never be paid back.
Anonymous   |     |   Comment #7
I try to owe as much as possible without getting penalized and schedule my payments for April 15. This year that was $65K for fed & state. The math is easy in years your income goes up a lot (just withhold enough to equal 110% of last year's tax, regardless of how much you make this year). In other years it can require computing estimated tax. Because of AMT it can be beneficial to overpay the state in certain years (mostly applies to high income tax states).
Anonymous   |     |   Comment #8
Take an IRA distribution in late Dec of each year and have taxes withheld that cover the ENTIRE year, i.e. nothing paid in earlier.  The distribution is in part QCD when allowed by Congress and an additional $5K tax withheld for hardcopy US Savings IBonds to be sent to Grandkids, etc. in lieu of refund of any "excess."
Anonymous   |     |   Comment #9
For the millions of low-wage and no-wage earners the large refunds they are getting every year under the earned income credit is definitely not a case of 'getting their own money back.' They're getting our money back.
Anonymous   |     |   Comment #10
And, your point is?  The moving of money around is what government does.  Be it corporate welfare or individual welfare!
Anonymous   |     |   Comment #11
It's obvious what my 'point' is to anyone who understands the English language. Contrary to the statement in the article, not everyone is getting their 'own' money back. The millions of people qualifying for earned income refunds are not getting their money back.They're getting other peoples money back. Corporations pay millions of dollars in taxes. No comparison.
Anonymous   |     |   Comment #12
Thumbs up good post!  But kindly remain aware, for some individuals, redistribution of our wealth is their path to political power.  Thus, these folks are less negatively disposed toward the EIC than are you and myself.  In addition, for certain individuals the Santa Claus role is fun and fulfilling.  This is especially true when they succeed in enslaving productive Americans, transforming us into their Santa's elves.
Anonymous   |     |   Comment #15
At what rate do corporations pay on taxes?  Did you read commenter #7?  I wonder if the corporate rate is more than his individual rate?
Anonymous   |     |   Comment #14
The vast majority of refund monies to low income folks (earned or otherwise) is immediately transferred to the economy, which is a good thing for everyone. I don't believe in subsidizing laziness and/or failure but the simple fact is we do not want desperate people roaming the streets. Also, not one person on this forum would trade places with any of the low income (working or otherwise) people I meet on a daily basis. In fact, most Americans know little or nothing about their impoverished fellow citizens. It's virtually impossible to maintain a sense of superiority when you look into someone's eyes and realize, "there but for the grace of God go I".   
Anonymous   |     |   Comment #16
Thank you for defusing the anger I felt at the flippant comments of other posters by posting your eloquent and compassionate response.
Anonymous   |     |   Comment #17
Great post. Couldn't have said it better myself.
Anonymous   |     |   Comment #18
Total nonsense! If the act of giving refunds to non-earners and low-earners is so beneficial to the economy, let's take the next step in your analysis and just give all these people a government payment of say, 40K a year. Think how much more of a 'good thing' , by your reasoning, that would be. Most Americans, contrary to your statement, know plenty about poor people. They see them on the streets every day and they are fed a constant stream of stories on this segment of society by the media on a 24/7 basis. Grow up, compassion must always be balanced with wisdom. When it's not, it does more harm than good.
Anonymous   |     |   Comment #19
Pray about it, friend.
Anonymous   |     |   Comment #22
A little prayer is always good for the soul. In your case, you need to pray for the wisdom to balance your compassion.
Anonymous   |     |   Comment #20
Poor soul. Enjoy your lucre.
Anonymous   |     |   Comment #21
The 'poor souls' are the fools who put Obama into office. The worst and most Far Left POTUS who has tried to turn this country into a Western European style socialist country and made a mess of Foreign Affairs.
Anonymous   |     |   Comment #23
Yea, I was disappointed too.  I thought he'd reverse the Bush prescription drug plan, stop the Bush initiated Bank bailouts, and expand Bush's war into Iraq.  Got it!
Anonymous   |     |   Comment #24
Right, 10 years into his second term and it's all still Bush's Are you comparing the prescription drug plan to the Obamacare disaster which is an income redistribution play? And it is agreed by every military expert analyst that the withdrawal of US forces from Iraq which Obama couldn't wait to complete is the reason ISIS is now entrenched throughout the Middle East. The man is without a doubt the worst POTUS in history. And makes a compelling case for the instituting of a required intelligence test in order to vote in a Presidential election.Hopefully, now you got it.
Anonymous   |     |   Comment #25
It only seems like 10, of course it's 6 loooong years.
Anonymous   |     |   Comment #26
Let's compromise.  Both presidents did not do the country any favors. Things were good when Clinton was president, but it ended when Bush started causing problems and now Obama is maybe even a little worse.
Anonymous   |     |   Comment #27
No one mentioned 40K and you obviously know nothing on a truly personal level about the truly poor. Typically, you have no depth of insight.
Anonymous   |     |   Comment #28
 The 40K number was used as a hypothetical example not because anybody mentioned it.The fact that you don't understand even that most transparent of facts is typical in keeping with your overall cluelessness.
dpandslemmen   |     |   Comment #13
My Goal is each year to get no more than a $1,000 refund from the Fed.  I do not want to ever pay a penalty of not paying the proper income tax.  I shoot for $1,000 because if they make any last minute changes to the taxes I at least have a little cushion.

This year I got $920.  Mailed the paper return on the March 9, received the direct deposit on March 20.
Anonymous   |     |   Comment #29
I like my method best.  The IRS does not give me a refund and I do not give them any either.

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