Not Getting a Big Tax Refund? You’re Actually Doing It Right

Kerri Anne Renzulli

Exerpted from MONEY, Mar 27, 2017


The average American who received a refund in 2016 got a hefty $2,860, according to the IRS. And while most people plan to do smart things with that windfall, such as shoring up savings or paying off debt, the question recipients should be considering is not what to spend that money on but rather why they got it in the first place.

A tax refund is simply the difference between the taxes you paid the government and the taxes you owe. Receiving a large refund means you've overpaid.

Ideally, you should aim to have no refund at all because then you've paid the correct amount of taxes and have not "made an interest-free loan to the government," says CPA Melissa Labant, director of tax advocacy for the American Institute of CPAs.

A big tax refund costs us not only the larger paychecks we could have been receiving throughout the year, but also the lost opportunity to use those funds. For example, if you receive a $3,600 tax refund this year, that's an additional $300 a month you went without in 2016. Let's say you have a $14,000 credit-card debt with an 18% interest rate. Applying that $3,600 to your debt as you earned it, rather than all at once the following spring, would have saved you about $300 in interest costs in just that single year, according to Bankrate's credit card calculator tool.

Or you could have applied those extra dollars from your pay to your 401(k), getting more dollars invested in a year when the S&P 500 stock index returned 12%.

Even turning those funds over to a bank account in this period of historically low interest rates would have reaped a better return than allowing the government to hold on to it. After all, even 0.06%, the current average savings account interest rate, according to the FDIC, is a better return than 0%.

However, if overpaying the government feels like the only way you can ensure that you save, be sure to treat that tax refund as forced savings and send those dollars directly to your savings account so you don't end up spending them on daily expenses or a treat.