Getting a big tax refund can feel really exciting. After all, you’re getting a nice check in the mail or a big chunk of money deposited into your bank account just for filling out some paperwork in the form of a tax return.
But while it might seem nice to get your refund payment, the reality is that it’s actually bad news to get a lot of money back from the IRS. Here’s why that’s the case — and some tips for what you can do about it if you discover that getting a refund isn’t right for you any more.
A refund is a return of your own money
When you get a refund, it can feel like free money since the cash shows up in a big lump sum. But it isn’t free money; it’s your money. And it’s your money that you haven’t had access to — sometimes for over a year if you pay taxes in January and don’t get a refund until after tax day in April of the following year.
When you get a big tax refund, you have essentially loaned the IRS a lot of your money. And you haven’t been paid a dime of interest or otherwise benefited from the fact you gave the government use of hundreds or even thousands of dollars that you could have been making good use of.
There’s an opportunity cost to lending the IRS so much of your cash in this way. Since you don’t have the funds, you can’t do anything else with them. If you had kept your cash, you could have invested it, paid down debt, or aimed to accomplish other financial goals throughout the year rather than just letting the IRS have it for months on end.
Let’s say, for example, that you had overpaid the IRS $3,207 (the average tax refund received by taxpayers so far for the 2023 tax year). That’s an overpayment of about $267.25 a month. If you were able to invest and receive a 5% return on your $267.25 in January of last year and then invest $267.25 every month until April of this year, you would have earned $173 in interest.
That’s quite a bit of extra money — especially if you’re giving that up every year because you consistently overpay the IRS.
You’ll also have your money tied up so you can’t use it for other goals. Say, for example, you have no emergency fund. You could have saved the $267.25 you were overpaying the IRS in a bank account, and the money would have been there for you throughout the year if you had a surprise expense. But instead, the IRS would have it and you might have to put your unexpected costs on your credit card. The IRS isn’t going to send your money back early just because your car breaks down or your kid gets invited on a class trip.
You don’t want to give up whatever you could have been doing with the money. There’s no benefit at all to overpaying the IRS and letting it hold your money captive.
How to avoid a big tax refund
The good news is you can adjust your withholding with your employer so you pay less money in taxes from each paycheck. This can help you avoid overpaying and getting that big refund you may not want, once you think more deeply about why you’re getting it.
The IRS has a tax withholding estimator, so use it to make sure you pay only the amount needed to comply with the requirement to pay your taxes as you go — and nothing more.
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