One of my neighbors recently had a beautiful new fence put in. While I was raving about how great it looked, she mentioned that they used their tax refund to pay for it - over $5,000. While I think it's great (and necessary) to pay cash for all big expenses, I wonder if getting a large tax refund is really the best way.
Basically, when you get a large tax refund you're lending your money to Uncle Sam for the year interest-free. In most cases, you're getting money withheld from your paycheck to pay your taxes, and then at the end of the year if you paid in too much you get some of that money back as a tax refund.
You can walk through the IRS Withholding Calculator to determine how many withholding allowances you should take and then use that information to submit a new W-4 form to your employer.
Rather than get a large tax refund at the end of the year, you would receive more money in each paycheck (since your tax withholding would be less). You can take that money and immediately transfer it to a savings account to go towards your emergency fund, a vacation, new car purchase, etc.
Why You Might Want a Big Tax Refund:
If you have trouble saving money for big purchases and would likely fritter away any extra money from your paycheck on non-essentials, then maybe it's not a bad idea to have an IRS "forced savings plan".
It works great for friends of mine who know that they would spend any money they would put in savings each month rather than actually save it. They use their tax refund to pay for their vacation or a new to them car.
Also, if you qualify for the Earned Income Tax Credit or Refundable Child Tax Credit, getting a large tax refund is how you get your tax credit. My husband also gets periodic bonuses, where his employer withholds more than usual for taxes. It can be more difficult to do accurate tax planning in that case.
Why You Want to Get Your Refund as Close to Zero as Possible:
Like I mentioned already, if you get a large tax refund you're basically giving your money to the government to hold for you all year and then getting your money back. It's not "free" money, since you earned it and paid for it with withholdings from your paycheck.
We personally prefer to have a lower withholding rate and save for things throughout the year using our budget. We get less of a tax refund, but we also get more money per paycheck.
There really is no right or wrong answer to the question. It's just personal preference and what works best for your family! How about you? What do you prefer?
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