You are expecting to receive a federal tax refund! It's like finding a forgotten hundred dollar bill in your winter coat pocket, but instead of just a hundred dollar bill, a refund can leave you hundreds or thousands of dollars.
As of April 15 last year, nearly 100 million Americans had received more than $ 2,700 on average from big Uncle Sam, according to IRS data. While American citizens love what appears to be money, financial planners are much less enthusiastic. They emphasize that a refund is not from the sky. To them, a refund means that you have saved a lot of money from your salary. It is like handing over an interest-free loan to the government.
Are refunds a reason to be scared or one to be happy for? We will look at some of the disadvantages of a big tax refund.
There is no financial advantage in not getting your money back from yours. A repayment means that you are giving the government cash flow and income with an interest-free loan.
The interest rate on US one-year bonds is around 1.5%; therefore, any interest that the government could hypothetically pay for this loan would be very low: approximately $ 15 for each payment of $ 1,000. But you can make a significant profit on this money if you use it otherwise, to invest in a business that pays high-interest rates, for example, or as part of a long-term investment that pays more than 1.5%. Your retirement account may be eligible for such investment.
Instead of getting the lump sum in April, you could spend the year paying a balance on your credit card, which costs 6% to 22% a year. You could spend the year investing an additional 1% in IRA or other savings, such as an emergency fund. An easily accessible account, which contains living expenses between three and six months, can be crucial to go through a period of unemployment or an expensive auto repair.
There is one more reason to ignore a tax refund: tax identity theft. The IRS has made significant progress in reducing this type of fraud, from 677,000 taxpayer victims in 2015 to 199,000 in 2018, the latest year for which data is available. This is done (in part) by carefully examining all the signs of problems, such as the incompatibility between the information contained in the tax returns and the data that the agency has on file.
If you don't get a refund, fraudsters can't steal from you, and it could save you a hefty fine. If you receive a refund and there is an indication of identity theft or fraud, the IRS will block your return until you verify your identity. This happens to 5% to 10% of taxpayers, anecdotally. If you belong to this group, you are expected to wait longer for your money.
Sometimes smart itemization and deductions can lead to a big tax return. Other times it is because people pay more taxes than necessary each month. Some taxpayers do this intentionally, ensuring the withdrawal of a surplus if their taxes are higher than expected. If you do not know what your tax will be and want to minimize your debt risk in April, this is a good strategy.
For half of the American families living on wages, paying more tax than necessary each month may not be the best financial decision. This is especially true if you continue to accumulate credit card debt or if you have unsecured debt with a high-interest rate.
Reassessing the amount you pay in taxes may reveal that you are paying more than necessary regularly. Adjusting your deduction at source is like receiving an immediate increase in your salary because you bring in more of your salary with each payment period.
Let's be honest. When people receive a large amount of money from a tax refund, a percentage of that money is used for discretionary spending. It is an unnecessary expense and can put your budget in the red.
What people with the extra money should do is pay down the debt (starting with the higher interest rate) or invest it so they can increase their assets.
Paying too much is like giving the government an interest-free loan
When you receive a refund, the government returns the money that was overpaid. But until then, the money was in the federal government's bank accounts, not yours. Instead of giving the government an interest-free loan, you can save extra money and earn interest.
