Big Tax Refunds are Great! Right?

There are all sorts of unending debates in the world of personal finance, with rabid followers on each side.  Rent versus buy?  Emergency fund or no emergency fund?  Paper or plastic?  Yes, some personal finance writers will go into a strange amount of detail about that last one.  One other burning question:  Tax refund or no tax refund?  Or big tax refund?  Or little tax refund?  There are actually more than one answer and as with many things in personal finance, it can depend on your situation.  But let’s talk about it and find out who the winner is anyway shall we?

The 2014 tax season (for the 2013 financial year of course) is in full swing.  People are waiting for the steady stream of tax papers in the mailbox (luckily you can download a decent amount of them nowadays) and deciding how they want their taxes done.  You can go to a local accountant, a big box one like H&R Block or just do it yourself with tax prep software like TurboTax.  I usually use a local accountant but am heavily leaning towards doing it on my own this time since computers make everything so easy.  There are lots of choices to make during tax season.  And there are two main things Americans want to accomplish after doing their taxes:  make sure the IRS will not be breathing down their neck in the future and to get the highest refund possible.

You can see it in advertising everywhere.  “We will get you your highest possible refund!”  There are promises of getting you your refund the quickest.  There are even some less than reputable establishments that will give you money even before receiving your actual refund, as long as you pay them back with your actual tax refund money.  Along with a big fat interest rate.  The fact is, getting a nice big refund and getting it fast seems to be the ideal situation according to the ads.  The average tax refund for 2013 was around $3,000.  That’s nothing to sneeze at.  I mean, who doesn’t want a big wad of cash delivered to them all at once?  That just sounds awesome.  But it’s not THAT awesome if you look at it objectively.

Getting a tax refund is nice, but it just means the government is giving you back money you rightfully earned in the previous year.  They thank you for the free loan.  Getting an average refund of $3.000 means that you could’ve gotten that money throughout the year.  That averages to $250 a month.  This can be helpful in paying down debt, especially high interest debt such as credit cards or student loans.  This is the main benefit of not getting a large refund.  If you can funnel that $250 every month towards debt or even just an online savings account, you will be ahead, maybe even far ahead, compared to just having that money held by the government until it’s time for your refund.

What about the case for getting a large refund?  Is there even a case?  There might be when psychology comes into play.  Emotions and psychology SHOULDN’T interfere with personal finance decision, but they do.  Some people are savers, and some people are spenders.  If you don’t do anything positive with that extra $250 a month and just let it sit in your checking account and increase your spending, then maybe allowing yourself to get a nice refund will be a kind of “forced” savings (though an automatic contribution to an online savings account would work just as well).  In any case, if you’re the type that might spend $250 a month without thinking about it but will be sure to spend your $3,000 refund on reducing debt or increasing savings or investments, then getting a big refund might be for you.  Ramit Sethi wrote a pretty good post a few years ago about this.  Though he assumes a tax refund of $600, well below the average.

My take?  I would opt for a refund as close to zero as I can get, but that’s because I have student loans to pay and it’s easy to tack on that extra $250 to my highest interest loan.  I would much rather use that increased monthly income to cut down on the amount of lifetime interest I pay on those loans.  But I won’t shout down those people who like big refunds and spend it on positive financial actions such as paying off debt or increasing savings.  I will, however, shout at those people who spend that big refund on a vacation or consumer goods.  If that vacation was something you wanted to do anyway, just stash that money into an online savings account.  You’ll at least earn some interest on it and will be able to use it in case an emergency happens.

As usual, this discussion on a hot personal finance topic ends…inconclusively.  Though I would lean towards having a smaller refund so you can use that money on something positive throughout the year, it’s not a HUGE deal if you go the other way.  People can do stupid things with large amounts of money, so be very careful when you do get that nice refund.