The chill in the air is getting old, and the catalogs in our mail boxes have been replaced with forms with numbers in their titles. It must be tax season. During the next two and a half months, we will be among the over 150 million Americans who will file their tax returns. I’ll bet you are looking forward to your tax refund. You shouldn’t be.
In the 2015 tax filing season, nearly three quarters of filers received a refund, and the average amount was almost $2,800. According to the IRS, these numbers are fairly consistent from year to year, so we can expect similar results for this year’s tax filing season. Given how much we hate paying taxes, its surprising that so many people pay extra taxes when they could avoid it. Yes, that is right. If you get a refund, you are paying extra taxes, so the government gives the money back to you after you file your return.
It would be one thing if getting a refund were due to making a mistake that you would correct once you understood it. But people have too much withheld from their pay for taxes year after year. There have been a number of studies around why taxpayers do this. Findings suggest three main reasons; the effort and uncertainty of estimating the correct withholding amount, fear of having to pay additional taxes at the end of the year and feeling like we’ve “won” when we get a tax refund. When it comes to taxes, we are pretty consistently irrational.
For most people, it is not too difficult to estimate the correct withholding amount for your taxes. You are paid regularly, you have a few personal deductions for your kids and mortgage, and that’s about it. The IRS provides a calculator that will cover most situations. If you itemized deductions on your last return and expect to do the same this year, you can use your return from last year to help you with the deductions section of the calculator. If you have last year’s information at your side, it shouldn’t take more than fifteen minutes to get the information you need to adjust your withholding amount. Taking the time to estimate your withholding will also reduce any anxiety you may have about getting it wrong.
While everyone enjoys getting a big check, getting a tax refund from the IRS is not a win. Its your money and the government is just giving it back to you. Back in the good old days when you could earn interest on your savings, allowing the government to use your money was obviously costly, but people still had too much tax withheld. Now that deposit accounts don’t pay much, if any, interest it may not seem like you are giving anything up by letting the government hang on to your money. However, here are a few things that you could do with it instead.
- You could use the extra money each month to pay down your credit card debt. If your refund would be the average of $2,800, adjusting your withholding amount to avoid a refund would give you an extra $233 per month. With the average credit card charging 15%, you would reduce the total interest you pay by almost $250 for the year and reduce your debt by over $2,500.
- You could add the extra monthly money to your retirement account. If you aren’t already getting your full employer match on your company sponsored retirement plan, you could instantly double your money. Even if you are getting the full match, with an average investment return of just 5.0% per year, you will almost triple your money over twenty years.
- No credit card debt and already maxing out your retirement contributions? Use the money to pay down your mortgage. According to Zillow, the median home value in the US is $183,500. Per FreddieMac, the current thirty year mortgage interest rate is 3.96%. These values would put your monthly payment at $871. If you were to add the extra $233 to your mortgage payment, you would pay off your home ten years sooner and pay $47,540 less in interest.
There are plenty of ways for your money to work for you, if you don’t give it to the IRS unnecessarily. Uncle Sam isn’t going to say thanks for the loan, so keep the money, and do something good for yourself.
Image courtesy of David Castillo Dominici at FreeDigitalPhotos.net