Some people aren’t great at saving. No matter how many articles they read about painless ways to save, there will always be people that find having extra money in their possession to be too tempting to spend. For such would-be savers, one potential “solution” is to adjust their tax withholdings and essentially have the IRS save for them. By having the feds take more of your paycheck each period, you’ll likely end up with a nice tax refund the following year. Sounds great, right? Not so much.
The truth is that this method may actually lead to no change in your personal financial situation. Even worse, it could lead to more spending and/or lost gains. Here are three reasons why getting a big tax refund may actually be a bad thing for your finances:
You’re just as likely to splurge once you get your refund
When are you more likely to spend: when you have $10 in your pocket or $100? This is exactly the problem with allowing your savings to come back to you as a lump sum — you’re just as likely if not more likely to spend it. Because of this, you’re probably better off setting aside money on a weekly or monthly basis and allowing it to grow instead of setting a money bomb for yourself each April.
You could be making money on your savings instead
Perhaps one of the reasons most consumers are apathetic to saving is that it doesn’t seem like their contributions will really add up to much. With many mainstream banks offering as little as 0.1% interest on savings accounts, can you really can’t blame them for that mentality? That said there are now a number of alternatives that offer much better rates on your savings. In fact, if you’re worried about spending what you accrue, you could even consider a certificate of deposit (CD), which will make it harder for you to access your money on a whim, while earning a higher rate of return.
Beyond regular savings, you might also consider options like retirement savings contributions that will also earn you interest while preparing you for the future (not to mention the potential tax benefits). For those with more to risk, investing is also a possibility. This could include traditional investments like stocks and bonds or perhaps newer opportunities like peer to peer lending — it’s really up to you.
You could be out of luck in an emergency
While spending money on items you don’t need instead of saving your funds can be a bad idea, there will be times when an unexpected expense turns out to be a necessity. This is where emergency and rainy day funds come into play. But there’s a potential problem: if an emergency hits and you haven’t received your expected tax refund yet, you may be forced to tap credit cards, personal loans, or even payday loans in order to cover costs. Meanwhile, had you been saving on your own all along, you may have been able to access that money and avoid other costly options. Above all else, this may actually be the number one reason to reevaluate your tax withholdings and give yourself more cash on hand.
Everyone loves getting a nice tax refund when they file but, in some cases, receiving a large refund may be a sign that you need to adjust your withholdings. Although some taxpayers have found success with savings by over-withholding, this method could actually backfire by allowing you to splurge more easily, robbing you of interest earning potential, and putting you at risk should an emergency expense arise. For those reasons and more, you may want to reconsider how much you’re withholding on your taxes and bring your refund back down to earth.