The IRS has been accepting tax returns for nearly a month now, which means that some of those early-bird filers are already seeing their refunds come in. Meanwhile, countless Americans are no doubt hammering away at those returns in an effort to get their money back from the IRS as quickly as possible.
Each year, a good 70% to 80% of filers end up overpaying their taxes and getting refunds as a result. And at first glance, that payout might seem like something to celebrate. After all, how often is it that you get a lump-sum check in the mail (or deposited into your bank account) that's yours to use as you please? But no matter how stoked you might be about getting yet another tax refund this year, you actually don't want to be in that position at all.
Why we get refunds
Our tax system is far from perfect, and among its many flaws is that it essentially puts the burden on us, as workers and taxpayers, to estimate how much we ought to be withholding throughout the year. Remember, even if you're a salaried employee, you're required to submit a W-4 that dictates how much tax you'll pay month after month. Get that form wrong, and you could end up with a major tax bill on your hands when you sit down to file your return.
In fact, it's that precise fear that causes so many filers to err on the side of overpaying the IRS. The logic is that it's preferable to get money back at the end of the year than to owe, because in the former scenario, you're snagging a windfall and in the latter scenario, you suddenly are stuck having to come up with a potentially whopping sum of cash.
The problem, however, is that most people are far better off owing money than getting refunds, and here's why: The bulk of Americans are extremely financially insecure. An estimated 57% of U.S. adults have less than $1,000 in the bank, while 39% have no savings at all. Throw in the fact that countless workers are saddled with credit card debt, and it's no wonder the idea of owing the IRS makes us embrace the opposite extreme.
But it's for these precise reasons that most Americans can't afford to be losing money in their paychecks throughout the year -- because we need that extra money for emergencies and without it, we're likely to incur debt. In fact, think about the last time you charged an expense on your credit card and couldn't pay that bill by month's end. Would an extra $200 in your paycheck have spelled the difference between racking up interest charges or coming out clean? If the answer is yes, then perhaps you'll begin to understand why tax refunds are not ideal.
That's not the only reason Americans should shy away from tax refunds. Though most filers this year are planning to use their refunds responsibly, a good 13% think they'll blow the money on something fun, but frivolous. Why? Because they regard that cash as free money, when in fact, it's actually just their money that they failed to collect upfront. At the same time, there's a good chance many of those folks have little-to-no savings and can't afford to be splurging -- and quite possibly wouldn't be if that money were coming in month after month instead of in one fell swoop.
A different approach to your taxes
My goal here is to help you realize that it's better to get more money in your paychecks throughout the year than to get a refund. But what happens if you end up underpaying and owing the IRS? Where will that money come from?
If that's your concern, here's an easy solution: Adjust your withholding to get more money upfront in your paychecks, and put the excess into a separate savings account. If, when you file your upcoming return, it turns out that you owe money, you dip into that account and pay your tax bill. And if you don't end up needing that money to pay the IRS, it's yours to keep. Meanwhile, if you run into a financial emergency during the year and want to avoid credit card debt, you can tap that account and replenish it later, which is far more cost-effective than accruing credit card interest.
Though owing money to the IRS during tax season may not seem like much fun, landing in that scenario isn't actually such a negative thing. If anything, it means you got an interest-free loan from the IRS as opposed to the reverse being true.
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