No one loves the idea of paying taxes, but if you're one of the millions of Americans who typically receive a refund, then you've probably come to dread tax season a bit less. Nearly 80% of U.S. tax filers receive federal refunds each year, and while some of those are due in part to tax credits and deductions, others are a result of straight-up overpaying taxes throughout the year.
The average American's tax refund is an estimated $3,120, and while it may be nice to get a check that size in the mail, it also means you lost out on the opportunity to put that money to good use during the year. And that's something you'll probably want to change going forward.
Better uses for that money
So why do so many of us wind up getting money back on our taxes? Much of it boils down to fear: Rather than risk owing the government money come tax time, we'd rather err on the side of paying too much. But that fear may be hurting your finances in more ways than one.
For starters, if you're carrying debt, then getting more cash out of every paycheck could save you a fair amount of money in interest charges. Say you owe $3,000 on a credit card charging 15% interest. If it takes you a full year to pay off that balance, then you'll end up wasting just over $250 on interest charges. But if you adjust your withholdings to get more money in your paychecks, and as a result you're able to knock out that loan four months earlier, then you'll save yourself close to $100 in interest.
Another consideration is your ability to turn your income into more money by investing. Let's say that instead of getting a $3,120 refund, you get an extra $260 in your paychecks every month. If you were to invest that money in stocks and score an 8% return (which is actually a bit below the market's historical average), you'd gain about $250 over the course of the year. Even if you were to take that extra money and do nothing more than stick it in a basic savings account paying 1% interest, you'd still come away $30 richer. Remember: That money is yours to grow, and if you lend it to the government instead, you could wind up cheating yourself out of even more cash.
It's not free money
One major misconception about tax refunds is that the money you get back is free money. In reality, it's your money -- money that should've been in your hands all along. But if you continue to look at that refund as cash that randomly fell in your lap, kind of like that $20 bill you once saw lying in the street, then you might feel more justified in spending it on something fun but unnecessary.
Of course, we all deserve a little treat every so often, but if the money you get back on your taxes is cash you should've been saving all along, then you'll really need to work to overcome the urge to spend it on gadgets, a vacation, or whatever form of instant gratification you tend to pursue. In fact, GOBankingRates recently conducted a survey to see how recipients intended to spend their refunds, and 13% admitted they were planning to blow their cash on a vacation or shopping spree. And while that may be a valid way to spend your extra money, it's not a smart way to spend your refund if that money should've been going into a savings account all along.
If you got a sizable refund on your last tax return, then it's time to consider adjusting your withholdings to put more cash back in your paycheck up front. Otherwise you're just giving the government an interest-free loan and losing out in the process.