Tuesday, February 21, 2017

3 Reasons A Big Tax Refund Is NOT Your Friend

So April 15th is nearing and you've been diligently collecting your W2's, 1099's, K-1's and all other tax-related documents. You sent them off to your accountant or did the return on your own at home and are now anticipating that big refund check. Then it finally comes and not only is it what you were hoping for, it was even more than you anticipated! Great right? Wrong! Many people believe getting a large refund on their taxes is the best when actually quite the opposite is true.

So why is a large tax refund a bad thing?

    It's A Tax Free Loan To Uncle Sam
You establish how much money you would like to withhold on your paycheck each year and people often withhold far more than necessary to ensure that they will not owe money come tax time. All that you're doing by withholding more money than you actually need to is allowing the government to use your money all year in the form of an interest-free loan. If you elected to withhold a smaller percentage from your paychecks you'd have more money to spend each month and less would be held by the government.  Think of it like this, if you are paying down credit card or student loan debts throughout the year you would have the ability to pay off more of those high interest loans sooner instead of lending the government your hard earned money for free. This is why it is imperative for you to discuss proper withholding and/or estimated payments with your tax advisor.

    Inflation / Purchasing Power Risk
Inflation can be explained with a simple phrase, a dollar today is going to worth less than a dollar one year from now. In other words, if you bought something for $1000 today, in theory, it will cost you $1,011.80 to purchase that same item one year from now. So when that big refund check finally does come your money has less purchasing power now than it would've had in the previous year. The Bureau of Labor Statistics has a great inflation calculator that you can try for yourself here: BLS Purchasing Power

    The Urge to Overspend
More often than not when someone gets a large tax refund they can't help themselves and end up spending most, if not all of it all on something they really don't need. If your withholdings are adjusted properly each year you'll receive a modest return if you get anything back at all. For example, if your return amounted to say, $2400. You would've had an additional $200 a month throughout the year to pay off student loan debt, credit card bills, a car loan, your mortgage, so on and so forth. Instead however, you get your tax refund of $2400 at one time and instead of using all of it to pay down various debt obligations you succumb to the urge to spend it frivolously.

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