With the end of January looming, tax season is nearly here. While most taxpayers aren't exactly looking forward to having to prepare their tax returns, they'd still love to get big refunds from the IRS.
Yet inevitably at this time of year, you'll see plenty of commentary talking about how bad it is to get a big refund. These articles point out -- correctly -- that doing so means that you're missing out on money that you deserve to get throughout the year. Even so, there are several reasons why getting a substantial tax refund can be a smart move that gives you a lot more financial flexibility. Below, we'll look at three of them.
1. It's the best way to deal with financial problems that larger paychecks probably wouldn't have prevented in the first place.
It's true that getting a big tax refund means that you've given up the chance to get slightly larger paychecks throughout the year. For instance, if you get a refund of $2,600, then you could instead have gotten a $100 bump in the paycheck you get every two weeks. Doing so would've given you $100 more to work with, potentially avoiding things like getting into debt.
Yet the problem that many people face is that they don't have the financial discipline to set that $100 aside -- or to avoid going into debt despite having the extra money. In effect, that unnecessarily large tax withholding from their paychecks acts as forced saving, and that increases the odds that the person will use their refund toward good financial ends once they've filed their tax returns. Conversely, it's easy to fritter away small amounts of extra money throughout the year -- leaving you with nothing in the end.
2. It gives you a big amount all at once.
There are many things in financial planning that work best when you have a relatively large amount of upfront cash at your disposal. Whether it's opening a brokerage account, making a down payment on a home mortgage, or buying a single share of an expensive stock, it can be a lot easier to take an amount like $2,600 all at once to put toward your goals than to find a use for $100 every two weeks.
In some cases, you can work around this problem. For instance, financial institutions often let people open accounts even if they don't have the required minimum balance, as long as they commit to making regular automatic deposits on a monthly or quarterly basis. That gives you access to the resources you need without having to have a big upfront cash payment. Yet if you want to choose an option that doesn't offer that flexibility, then having the big tax refund as your lump sum can be quite useful.
3. You need the visibility and encouragement of taking a big leap forward.
It's true that by adjusting your tax withholding, you can get access to small amounts of extra cash that you can use toward financial goals. Yet if you do it that way, you'll take only tiny steps forward, and although they'll add up to significant progress, it might not feel that way.
Many people would rather take big leaps all at once. A tax refund that goes toward paying down debt, building up savings, or investing in a stock with high potential for future gains can be a lot more satisfying than repeatedly setting aside $20, $50, or $100 toward a long-term goal that will take decades to achieve. Having a big tax refund lets you make all that progress at once.
Use tax refunds wisely
Critics of tax refunds are right from a mathematical standpoint, because it's better to get money earlier than later. Yet many find it easier to do the right thing with big tax refunds. If you're one of them, don't let naysayers force you to make a change that you'll regret. Just go on doing what you're doing, and enjoy the psychological boost you get from putting your tax refund to good use.