I just finished my taxes. I need to have an accountant look at them, but I’ll be getting a rather large tax refund.
If my math is right (and only my accountant can let me know if it is) then my refund will be nearly $8,000. The first thing I did was talk to my employer to see how many exemptions I was claiming, and adjusted those so that I won’t be getting that much back next time.
Everyone says you don’t want to give the government an interest free loan – you want to keep the money each month.
Certainly, it would have helped me reach my goals faster in 2012. I would have paid off my student loan last year.
But there’s a flipside. Last year, I hustled to earn extra money to meet my savings goals. I wonder if I would have been so diligent if there were more money coming in. Living lean means picking up extra work whenever it’s offered because I was heads down determined to get out of debt and start making my money work harder for me. Would I have done that if I hadn’t been living so close to the margins?
It’s hard to say.
I think that the 2013 version of myself, the one who writes about personal finance, logs into Personal Capital three or four times a week, and has six or seven savings goals, should not get a huge refund.
On the other hand, tax refunds have been really useful in my life. In 2010, it was the tax refund that allowed me to put money down on a used car. In 2012, the refund was almost the exact amount of the remaining credit card debt. This year, I’ll use the refund to finish paying off my car.
Who Should Get a Big Fat Tax Refund?
I think most people in the beginning stages of taking charge of their personal finances (just out of college, first real job out of college, or starting to pay off credit card debt) should claim no exemptions, and therefore get the maximum amount taken out of their paychecks and loaned to the IRS.
Because the IRS gives it back.
Sure, not with interest.
But the group of people I’m suggesting go this route are not earning interest (or much) anyway. And taking zero deductions will make them feel more poor than they are. Which will make them live more simply. They will be less tempted to splurge.
Then, at the beginning of the year (right after they get their documents from their employer if they want!) they will get a refund.
Then, in an ideal world, that refund will go directly toward long-term savings goals.
Or not!
Sound Silly? This Isn’t For You
You can make more money in the stock market. I get that. I really do.
But lump sums can really help those of us living in the margins (for whatever reason!).
And, really, I’d recommend it to most people. Except those who are making plenty of money and saving 50% of their after-tax income.
Because “high interest” savings accounts are ringing in at around 1%, if you’re lucky.
And truly, an extra few hundred dollars a month could get you into the lifestyle inflation that everyone warns against. You’d spend it without even noticing.
What I Plan on Doing With My Refund
When my refund comes back, my bank account will be fatter than it’s ever been. And that worries me a little bit. I’m frugal by design, but I’m frugal because I need to be able to stretch a dollar. I don’t want to relax that attitude, and end up going out to happy hour instead of go grocery shopping, simply because I might feel like I can afford to.
So, I will be hiding money from myself. Not in my mattress, no. But I’ll pay off my car loan, then I’ll put the rest into my IRA, and be maxed out (or darn close!) for the year.
Then I’ll open a “high interest” account at a different bank, and put my savings there. That account will be hidden from my Mint. Out of sight, out of mind, right?
I understand the real value of living simply and being frugal.
I just know that in order to achieve my goals, I need to create systems to trick myself into saving money.
What do you think, will you change your withholding? Do you like to get a big refund?
Kathleen writes at FrugalPortland about her path to financial independence as well as ways to save money, live simply, and enjoy the fun things that Portland has to offer.
My Financial Independence Journey says
My preference at this point in my life/career would be a small yearly refund. That way I keep most my money with me. Don’t have to waste time with the hassle of cutting the government a check. And still feel good about getting something back.
Pauline says
I wouldn’t like a big refund because I don’t like to lend free money to the government. That said, I have done a similar thing you did, getting rid of a lump sum so that I feel pressured to make extra money. Having an $8K cushion would definitely feel cozier and help settle instead of fighting.
Brick By Brick Investing | Marvin says
Like you I fully understand the logic behind not giving the government an interest free loan I really do, however the money I use to get back before we had to start paying taxes every year would allow me to knock out some goals instantly. Of course logic says I could have methodically knocked out these goals throughout the year but we would all be lying to ourselves if we said every budget or savings goal goes without a hiccup. By the government holding my money it ensured it would be there at the end of the year in order fo rme to make a lumpsum payment.
This argument is similar to the argument that you should pay your debts with the highest interest down first rather than your smallest debts. I personally advise to pay down your smallest debt first so you can feel the accomplishment!
Money Beagle says
I agree with you. I see nothing wrong with getting a refund. First because interest rates in savings accounts aren’t that great and even though the government is getting an interest free loan, with accounts paying less than one percent, that is pretty negligible. Second, if you get that money throughout the year and you spend even 1% off it, you’re still coming out worse off than if you let the government have the loan interest free, so the out-of-sight, out-of-mind can end up saving you money. Third, the stock market can go down just as it can go up. Murphy’s Law would likely state that if you started funneling money into the market, it would surely go down. At least that’s the way it usually works for me 🙂
SavvyFinancialLatina says
We are actually getting a big tax refund this year too! I’m debating whether to claim more exceptions, but I just don’t want to owe the IRS money. And you are right, it is easier to save a big chunk of money than save $50 or $100.
I usually transfer savings every paycheck in the hundreds to notice a big change in savings. It’s psychological.
John S @ Frugal Rules says
We used to get a big refund and I always did when I was first starting out. The last few years we’ve tried to get it as lose to 0 as possible because I’d much rather have that money throughout the year. This year, we shall see as it was the first year that our business was “full-time” and we could not fairly estimate what expenses we’d have to write off. I can certainly understand liking to have that lump sum to pay something off or get something you need, heck, I have done that and it always felt good. However, a $1 today is worth more than one a year from now so I’d rather have it now.
William Cowie says
I love how you think, because that’s the way I work, too. 🙂
I’m retired now, but when I was working I always had my employer tax my paycheck with zero deductions. The interest you lose by letting the IRS sit on your money is really negligible, and the benefit of “out of sight” was (and is) worth it to me. And, it may sound silly, but every year we look forward to tax season instead of dreading it. Because now the question always is: how much will we get back this year? Life is so much nicer every year when tax time is good time, rather than stress time. Which, of course gives us great incentive to get it done early and not get caught in the April 15 crush. In all, well worth the pennies in interest we forgo.
My wife and I have come to look at the refund every year as the annual budget for: what do we want to do this year? Last year we repainted the house, two years before we installed air conditioning (what took us so long to do that?). And each year we intentionally bump the emergency reserve fund by another $1,000… just because.
Edward Antrobus says
I owed last year. It was a sinking feeling in my stomach, and unexpected (and therefor unbudgeted). Money that was tagged for paying debt all of the sudden was going for paying taxes. Never going to happen again. And you are absolutely right about the interest argument. Am I really worried about the dollar I’m loosing out in interest this way?
Kevin Watts says
Good post. I got my refund last week and it was $3800. I used all of it to pay my student loan. It has significantly reduce my student loan debt, I just have one 1 more month to go. Funny, I just started using Mint and I didn’t know you can hide an account in it.
Rob @FinancialSprout says
I agree that the lump sum can help alot of people! My dad isn’t always the most frugal person, so if he doesn’t have the extra money he can’t spend it. When we get our tax returns we use them to pay down the bills. It can also be tempting to spend the money on a toy, which is not so good. Everything has it’s pros and cons.
Listen Money Matters says
The lump sum is awesome, but I would say that more often than not people use the tax refund to justify spending as normally happens when people come into a large amount of money. I think it would be better to understand that you might not save as much month to month with more in your pocket but work on conditioning yourself. In the beginning, yes, you may spend more but with practice and discipline you’ll be putting the interest on those savings in your pocket and not the governments.
John Scheele says
Saving thru tax refunds and paying off debt are financial planning tools that can help you achieve you financial goals. I make use of three spreadsheets for financial planning that help keep me on track with my own goals. One is a annual budget broken down per month. Another is a portfolio tracker, which could include debt levels, and finally a long term cash flow projection sheet that can be used as a tool to use to check out what-if situations. If you do not have or not use these computer tools, you can get them for free thru Open Source.org.