Though most scream for joy when a check from the Internal Revenue Service (IRS) arrives after doing their taxes, you shouldn’t if you get a refund. That’s because you could be losing out on even more money. Consider adjusting your withholding so that more cash falls into your pocket each time you get paid. That way, you can invest that money earlier and make it work for you, rather than letting it collect dust on Uncle Sam’s shelves.
There are many reasons workers across America pay more than they need to on taxes via paycheck withholding. The most obvious is that they don’t want to write a check to the government during tax filing season for having not payed enough over the previous year. Secondly, paying too much, and subsequently getting a refund the next year, becomes a sort of forced savings, as many Americans don’t trust themselves to be disciplined. While withholding too much on each paycheck has good intentions, it carries very little financial benefit — unless you would waste that extra money.
A refund is the government saying you gave too much, and returning the money. You earn no interest. If you factor in inflation, you’re actually losing money on this loan. Consider this: $1,000 in 2012 equates to $1,014.65 for 2013. Thus, if you received a $2,000 refund in 2013, you’re actually losing nearly $30 in spending power for that next year. Additionally, that $2,000 could have been used throughout the year to improve your financial situation via investment, debt repayment or other activities.
The IRS has withholding calculators that can help you figure out the exact amount that should be withheld from your pay. If you have been paying too much, adjusting your withholding will lead to a bigger paycheck. That extra money can be used to establish a much-needed emergency fund. Or you could pay off debt, which can save you lots of money over time if you have credit card debt or other high interest debt. You can also choose to direct more of your paycheck toward a 401(k) plan or IRA; factoring in compound interest over time, this could give you an even more secure future. Similar to putting a larger percentage of your income toward retirement, you could also invest that extra money in bonds, stocks, mutual funds and alternative investments; if you invest wisely, you could end up turning that extra paycheck money into much more than a IRS refund.
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