The following is a guest post from Michael at Money Beagle, who believes that a balanced approach to money management is the key to financial success. He blogs about many personal finance topics from getting out of debt to saving for retirement to tips on staying clutter free around the house, with an emphasis on ‘personal’.
There are many things that most personal finance bloggers agree upon: Saving is good. Credit card debt is no good. Retirement savings, absolutely. Borrowing from your 401(k), not so much.
One of the most commonly agreed upon pieces of advice I’ve seen is that you should strive not to get a tax refund. The rationale behind this advice is that you’re giving the government an interest free loan. The advice is to adjust your withholding so that you essentially divide your tax refund up among your paychecks throughout the year. If you stick that into savings, you get interest throughout the year.
Reading those items, it sounds like a no-brainer that everybody should follow this advice, right?
I say, not so fast.
If that’s the strategy you want to take, I say continue on. If you’re already taking this approach and have it down pat, then carry on.
But, if you’re getting a big refund on your 2011 taxes and are considering employing this strategy, I think there are better uses of your time.
Let me run through the reasons that I think having a tax refund is not a bad thing:
- The interest rate benefit isn’t there – As recently as a few years back, the main reason for arguing for the ‘no refund’ goal was because you were losing out on a lot of interest. If you got a $4,000 refund rates were 5%, you were effectively losing out on around $100 in interest (I calculated this by figuring 5% on $2,000, which is the ‘average’ amount your fund balance would have over the course of the year). Nowadays, interest rates on even the best savings accounts are 1%, so you’re looking at $20 in interest. I’m not sure that’s worth it, especially when you consider…
- Out of sight, out of mind – When you overpay on your contributions, you’re not only giving the government an interest free loan, you’re also preventing yourself from spending it. How many people would look at their growing balance over the course of the year, and give in to temptation and buy something at some point that you might not otherwise purchase? If the cost of whatever you buy is over $20 (using our example from the previous bullet point), you just killed the entire benefit of earning the extra interest.
- The big bang theory – Again, looking at the example of the $4,000 refund, if you get that refund, there’s a certain psychological high that goes along with doing something big with it. I’m talking doing something responsible here, like saving or paying down a debt. Seeing your emergency fund jump from $1,000 to $5,000 all at once, or seeing your student loan balance drop by a third with one click of the mouse will give you a rush, and can give you extra motivation on hitting your positive financial goals.
- You could miss – Tax codes and other things change all the time, so even if you adjust your withholding so that your expected tax refund goes to $0, you could end up with a change where you could get a refund anyways, or actually owe money. Granted, if you’re doing it right, you would have the money in an account to pay it, but what if you decided you were going to pay debt throughout the year and then had to scramble to get together the money to pay your shortage?
Don’t get me wrong. I don’t think that adjusting your withholding is a bad strategy. I just think there are better options of things that you can do with the precious time that you put toward improving your personal finances.
Do you typically get a tax refund? Do you take any actions in regards to your expected tax liability throughout the year?