Income Tax Refunds: We Have No Interest

According to the Internal Revenue Service, in fiscal year 2010, 109,376,000 Americans received an income tax refund averaging $3,003.00.  This means taxpayers overpaid their income taxes by over $328 billion.  In essence, Americans gave the Federal Government  a 16-month interest-free loan of hundreds of billions of dollars.  Any financial advisor would tell you, it is a bad investment and would advise you to adjust your income tax withholding.

Every year millions of Americans anticipate getting their income tax refund, and getting a nice fat check every year is certainly enticing but not smart.  With the tough economy, by adjusting your tax withholding you could put your money to use when you need it most.  Why wait 12-16 months?  Some taxpayers may see a tax refund as something of a forced savings account but again, you don’t earn any interest. It’s like burying your money in a coffee can in the back yard and digging it up a year later to use.  Would you put $3,000.00 in your bank for them to use without being paid for it?  At the very least, at a 3% interest rate, an additional $90.00 is more than you had at 0%.

If you consistently receive a large refund, you have miscalculated your withholding.  Visit your Human Resources Department at work and get a new copy of your W-4.  If you are self-employed  go the IRS and download a new copy of a W-4.   Adjust the form to increase (or decrease) the number of allowances.  Keep in mind any changes in your marital status, dependants, or making a major purchase such as buying a house or vehicle will impact your witholding status.   Be careful not to withhold too much or you could end up paying taxes next season.  Not sure how much to withhold?  Visit the IRS website and use their tax withholding calculator.

It is a fact that many taxpayers spend as much as they bring home, so overpaying taxes may make sense to the less disciplined.  Just having a four figure check deposited into your bank account once a year may be for you.  However, if you consider yourself a savvy money manager and budget wise, adjust your income tax withholding, unless you think the government needs another interest-free loan from you.