While nobody likes doing taxes, most filers are ultimately rewarded for going through the hassle in the form of a tax refund. Though the numbers fluctuate year after year, generally speaking, close to 80% of tax filers wind up getting some sort of refund, and it's not always a small amount. In fact, as my colleague Matthew Frankel reported not so long ago, the average American's refund for the 2016 tax year, based on data collected to date, was $2,763 -- a 2% increase from the previous year.
Here's the problem, though: Even if you earn a relatively healthy salary, $2,763 is a pretty sizable chunk of cash to collect after the fact. It therefore raises the question: Should the average American be getting a tax refund at all?
Let's take a moment to think about what a tax refund really represents. Many recipients regard those refunds as free money, but it's that skewed line of thinking that gets folks into trouble. Contrary to popular belief, a tax refund is by no means free money. Rather, it's money you earned during the year but didn't collect until many months after the fact. And given the number of Americans living paycheck to paycheck, the typical tax filer shouldn't be aiming to get a refund at all.
You probably need that money sooner
In a recent GoBankingRates survey, 69% of U.S. adults admitted to having less than $1,000 in the bank, while 34% owned up to having no savings at all. These findings are consistent with a Federal Reserve study that found that nearly half of Americans aren't able to cover a $400 emergency. Rather, they'd need to borrow money or sell off possessions to raise that amount of cash.
Since the majority of Americans have little to no savings, it's fair to assume that most folks don't have much, if any, wiggle room in their budgets. And if you're one of them, that's precisely why forgoing a portion of your earnings each month is a very bad thing.
If you receive a $2,763 refund like the typical American, it means you're giving up $230 of income each month. And that could spell the difference between paying your bills and covering an emergency or racking up credit card debt in the absence of cash.
Furthermore, it's lower earners -- those who really can't afford to lose part of their pay up front -- who are statistically the most likely to get a refund. Back in 2012, 84% of tax filers making less than $25,000 a year received a refund, compared to just 34% of those earning above $200,000. That year, the average refund among lower earners was $2,086, which means those who were already struggling to get by gave up $175 a month -- money that could've been instrumental in helping them stay afloat.
Now some might argue that when you get a refund, you're not giving up that money so much as delaying its receipt. But because so many tax filers regard their refunds as free money, they tend to spend that cash less responsibly. In fact, in another GoBankingRates survey, 16% of tax filers who received a refund this year said they plan to use that money to splurge on a special purchase or take a vacation. On the other hand, had those folks received that money month after month, they might've used it to build some emergency savings, fund their 401(k)s, or pay down costly debt -- things you're supposed to allocate a portion of each paycheck to cover.
In fact, a big reason the average American should not be getting a tax refund boils down to perception. And until we all learn to view refunds for what they are -- delayed compensation -- we're likely to keep making the same mistake over and over again.
Stop the madness
If you're ready to come to your senses and put an end to the practice of giving the government an interest-free loan year after, there's a very simple fix. All you need to do is adjust your withholding on your W-4. In fact, you can use this helpful calculator to see what sort of changes to make.
Of course, part of why so many workers get refunds is that they're afraid of owing money to the IRS during tax season. But here's an easy remedy: If you adjust your withholding to collect more each paycheck, you can take that extra money and put it in a dedicated savings account. If you find that you need that money during the year (say, to cover an unplanned bill), it's yours to use right away. Otherwise, you can let it collect interest over the course of the year. Then, if come tax time, you find that you did underpay your taxes, you can dip into that account to pay the IRS its share and keep the rest, including your interest income, for yourself.
Remember, a tax refund is not the same as a gift or a bonus; it's money you earned but failed to collect at a time when it could've better served your needs. And once more Americans realize this, they'll take steps to stop getting refunds and start getting their money sooner.