Though we're well before the point when Americans will start collecting refunds for the 2018 tax year, thanks to the recent tax overhaul, a large number of workers are already anticipating money back from the IRS next year. Of course, it's always tempting to spend a windfall on things like vacations, electronics, and other such immediate quality-of-life enhancers, but the reality is that most people would be better served using their refunds more responsibly. And there's some good news in that regard: When asked what they'd do with a refund, "pay off debt" was the most popular choice among U.S. adults, according to a recent survey by GOBankingRates.
There's no arguing the fact that paying off debt is a smart use of a tax refund. But the reality is that more Americans might manage to avoid debt if they weren't overpaying their taxes in the first place.
Tax refunds are bad news
Many of us are wired to believe that getting a tax refund is a good thing. After all, it means free money from the IRS, right?
Tax refunds are actually the opposite of free money -- they're earned money that you should've gotten access to during the year but instead chose to lend to the U.S. government for nothing in return. And if you're in debt, it's that delayed access, so to speak, that might've landed you there in the first place.
Imagine you wind up with a $2,000 refund for the 2018 tax year. Now let's also imagine you racked up $2,000 in credit card debt between January and December because you didn't have savings (which is the case for many Americans), and your paychecks couldn't support the extra expenses that popped up during that time. You might think something along the lines of, "No big deal -- I'll just use my refund to pay off my debt, and everything will be even." Except it won't be even, because you'll have racked up interest charges on that debt, yet you won't collect interest from the government for having held onto your money erroneously. See the problem?
While it's never fun to owe the IRS money during tax season, too many Americans let that fear influence them to overpay their taxes throughout the year and then struggle financially because of it. And that's a cycle that just plain has to stop.
Avoid debt the next time around
If you're planning to use your upcoming tax refund to pay off debt, know that you're doing the smart thing for your finances given the situation you're already in. At the same time, take steps to avoid a repeat the following year. If you're a salaried employee, you can start by adjusting your withholding so that you're having less tax taken out of your paychecks week after week. If you're self-employed and expecting a refund, you can scale back on your estimated quarterly tax payments.
Any extra money you get in your paychecks as a result of those adjustments shouldn't be blown on nonsense, however. Rather, you should stick it all in the bank, especially if it's your first time having less tax withheld. The reason? There are factors outside of your paycheck that can influence your total IRS tab, and this way, if it turns out you owe a little money on your taxes, you'll have savings to dip into to pay that bill, and anything left over is cash you get to keep. At the same time, you'll get to earn interest on that extra money in your paychecks, as opposed to letting the government play around with your cash. And that sounds like a much better deal than risking debt -- or actually racking it up -- because you're waiting on money that's rightfully yours.