Big Tax Refund? You’re Doing It Wrong

You probably know someone who calls a big tax refund a “government vacation fund,” getting back $4,000 to $5,000 every year in a federal tax refund and a smaller amount on a state refund.

That’s what happens when you over-withhold every year. You consistently get a large refund.

The continual problem, however, is that this “forced savings” account gets spent immediately on a large, expensive vacation, such as spending a few weeks in the Caribbean.

Compounding the problem further, you might end up with a bunch of charges on your credit card while you are there, coming back with more credit card debt than you left with.

After doing this for several years and not paying down on the debt, it finally gets to the point where the “forced vacation” fund has to be spent on paying down your credit card.

Unless you have no discipline whatsoever, there are better ways to allocate refunds.

First, why go for a large refund in the first place? Set your withholding such that you receive a minimal refund (or pay in minimally) each year.

Getting a large refund back isn’t something to brag about. Rather, it says that your tax management techniques need work. Work with an accountant or tax preparer to tweak your withholding amounts at work.

After adjusting withholding, more money should appear in your paycheck. Use that money to benefit you in ways other than spending on wants.

For instance, build up your emergency savings fund. Pay down short-term, unsecured loans, such as those credit cards.

Peace of mind

Paying off the high interest on those cards will give your balance sheet an immediate boost. Then think about saving more, either through your workplace retirement plan or perhaps through a Roth IRA.

For instance, have you covered all of your family’s risk areas?

Take a look at your life insurance coverage, your disability income coverage and your property and casualty insurance policies and adjust them if needed.

Gotten a will and powers of attorney done yet? Take a bit of that refund and cover those bases!

If you’ve satisfied all of those areas, well, put any leftover cash into a real vacation fund!

MarketRiders, Inc. is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.