At this time of year, many people get tax refund checks from the government. Mine came today, by direct deposit - a whopping $200. But many folks get $1000, $1500, or even more, and are convinced this is a "good thing" - after all, the government is sending them money!
But of course, they are just sending you back your own money after borrowing it for a year, interest-free. If you are getting a huge refund, then chances are, you are not planning your taxes very well. And in most cases, it is very poor people, or middle-class people who make poor financial decisions who relish these big refunds.
For example, one person tells me, "I love getting my refund! It is like a savings account that pays off every year!" And yes, it is a savings account, that earns zero interest.
But, of course, given the fractional rates of return these days on savings accounts, maybe this is not such a bad thing. Unless of course, you also have debt.
Another person tells me that they "Pay off their credit card" (or pay it down) with their tax refund money. This is probably better than some other approaches (see below) but it also is poor planning. Why? Because if you are carrying credit card debt at 15% interest all year long, and then paying Uncle Sam more than he needs, and getting 0% interest on that money, you are in effect, running up an unnecessary credit card debt, to the tune of your tax refund.
That money, applied during the year to your credit card, could save you a lot of money in interest payments. And if that amount of money is what you are running up on the card, maybe you could afford to pay cash and not charge things.
Using the IRS and tax refunds as a Hillbilly Savings Account is not a good idea - it is just poor financial planning, period.
But I said it gets worse - and it does. For many people, spring is the time to go out and spend money - on motorized vehicles, of course. And car dealers and jet ski purveyors rely on the tax refund as a "down payment" for a car, jet ski, boat, or motorcycle. And a lot of poor financial planners do just that. Every year, the "tax refund" is used as a down payment for yet another debt obligation, to clutter up the yard with an other internal combustion engine.
Thus sudden pool of money is not viewed as an opportunity to improve their financial picture, but rather as a means of going further into debt.
So how do you get around this? You can adjust how much is taken out of your paycheck by altering the number of exemptions. It is not an exact science, to be sure, but the withholding amount taken out is supposed to track how many "exemptions" you have - you, the spouse, the children.
However, you can alter this amount if you want, claiming zero exemptions (if you think you may have a higher tax burden from other income sources and would rather not pay "estimated taxes") or go to higher numbers. You don't have to have four kids to claim six exemptions.
But again, this is not an exact science, and you have to be careful. If you claim six exemptions, then the amount of tax taken out might not be enough to satisfy your tax bill, come April 15th. At that point, you have to cough up the money, and if you don't, there are penalties that may be applied. Also, underpaying taxes through the year can result in penalties in some States.
Withholding is the most powerful weapon the IRS has, and they don't want people messing with it.
However, if you are getting a $1500 refund every year, and have a $3000 tax bill, you may want to change the number of exemptions you are using - going up by one, for example. You can do this by filing a new W-4 form with your employer.
Ideally, when tax time comes around, you should end up getting back a small refund or owing a small amount - a few hundred dollars either way. That means you have correctly estimated your taxes for that year, rather than wildly over-paying or under-paying them.
The other day, on NPR, they interviewed some brain-dead mouth-breather who said, "I put off filing my taxes this year. Last year we owed a lot of money and I just didn't want to deal with it this year."
That is an intelligent approach to taxes, to be sure. Yea, she was from Georgia. Go Figure.
Doing your taxes at the last minute is dangerous and let me tell you why. When my accountant was dying from a brain tumor, she extended my tax due date. Unfortunately, this meant that she was unable to calculate my taxes ahead of time. I found out, too late, that I owed $20,000 in Capital Gains taxes, and had two days to come up with the money. OUCH.
I was able to handle it OK,but it illustrates why the tax business is one area where procrastination is NOT a good thing. And thanks to Turbotax, you can go online in January and sort of do a rough guess on your taxes early on - and have three months to plan on how to pay them. And as April 15th gets closer, you can refine your return and figure out the actual amount.
But living in denial? Not sure that is a good plan.
Figure out what you owe in taxes and pay that amount. Paying too little or too much during the year is not a good idea. You CAN adjust your exemptions on your W-4 form to tailor your withholding to your actual tax bill. But don't go crazy - and start calculating your tax bill early on, so you won't have a nasty surprise in April.
If you are getting a huge refund check every year, don't congratulate yourself. Because you are making a poor financial decision.