Now that we have April 15 a few weeks behind us is a good time to think about the coming tax year and whether you want a bigger paycheck or a big refund. While the answer to this question may seem easy it’s actually more critical than you could guess. While the majority of us elect to get a nice check from the government in April the fact is that a huge tax refund might not really be so terrific. In fact, some experts say it’s better to give up that big refund in return for getting additional money in each paycheck as this would give you more control in maximizing your income. Of course, there are other financial gurus who say that this is an idealistic approach to saving. The harsh reality is that some of us, including you, may not be trusted to put the extra money in a savings or investment account instead of spending it.
Why you should have more money in your paychecks
There are literally dozens of books about personal finance, including the number one best-selling “Rich Dad, Poor Dad,” that leave no question about it. You should take more money in your paychecks and not a bigger tax refund. The author of “Rich Dad, Poor Dad”, Robert Kiyosaki, explains that for every dollar we get we can either spend it or invest it. He says, “I’m not one to advocate living below your means, but suggest, instead, that we ask ourselves ‘how can I expect to expand my means?’ One way to do this is to focus on investing. And even small amounts on a regular basis will put you on the road to having your money work for you.” In addition, if you get more money throughout the year in your paychecks this offers the opportunity to create an emergency fund if you don’t already have one. That way you have cash available to handle unanticipated expenses instead of having to put it on a credit card, which probably means adding to your debt.
Another way to look at this is that if you get a large refund check it means that you’ve paid to much in taxes to the IRS. This means you’ve basically been giving it a loan for a year interest-free. Since our government won’t ever loan you money for free why should you lend it money for free?
The case for getting a big refund
We suppose that financial experts just tend to disagree on some things. This is because in many cases there is just no clear-cut answer and this is one of them. For example, there is also a school of financial experts that believe it’s better to get a nice refund in April. The reason for this according to one expert is that it’s best to get a big chunk of money at the end of the year. However, if this were an ideal world you would bank the money you received during the year in your paychecks. Unfortunately, nine out of 10 times what people do is end up spending the money. These experts say that if you get a big tax refund you might be prompted to do something immediately and save or invest the money or use it to pay off a debt. If you have your finances in pretty good order there is just no good reason to give the government an interest-free loan by letting it keep a part of your income throughout the year. Of course, if you’re short on financial discipline and were to have more taxes taken out of each paycheck then necessary you would be required to live on less money but would then have a windfall in April that you could ideally deposit into savings or investments. On the other hand, if you don’t have much in the way of financial discipline you could end up spending that tax refund on a new HDTV instead of investing it in savings.
Either one can work
It’s not bad if you want to get a big refund in April so long as you understand you’re giving the IRS a loan interest-free and that you are a responsible person and will make a good decision with the way you use that big tax refund. It’s also not bad to take the money during the year and end up with a large tax bill so long you’ve planned for it and have been earning interest on the money. On the other hand, it can be a type of forced savings account when you have the government take out more money than necessary so that you can get a big tax refund. This can be a good plan for people who need an extra push to save or invest.
Today’s interest rates
There was a time not long ago when it was best to get more money in your paycheck and put it in a savings account where you could collect up to 5% interest. However, these days when experts tell you it’s best to get the extra money in your paycheck so you could save it they neglect to say that you’ll get basically nothing in most savings accounts that pay interest. So, a case could be made that unless you have an investment account that’s returning 5% or more you might just as well get all that money together in the form of a big refund where you could then invest it in something that would get you a decent return.
There’s no doubt about the fact that the logical thing to do is give up that large tax refund and get control of your money. But then you may not always be logical. Given that there are few options today to maximize your savings, plus the fact that you may not be saving hardly anything at all, then a nice large check from the IRS might be your only chance to build a nest egg. And no, the government isn’t going to pay you anything on that “loan” but it’s also not going to pay you anything on your savings. Until interest rates change don’t feel bad about getting a big refund this year. Just make sure you save some of it.
The case for using your refund to pay off credit card debt
One of the best ways to use that big refund check is to pay down or pay off your credit card debts, especially if you’re carrying a large balance. Most credit card interest rates these days are at 15% or higher. For the sake of an example let’s suppose you owed $5000 at 15% and your minimum monthly payment was $112.50. If this were the case, it would take you 266 months to pay off the $5000 and would cost you $5729 in interest – or more than the actual balance. Use your tax refund to pay off this debt and you would not only save $112.50 a month, you would save $5729 in interest – which is a lot more than you could ever earn by saving or investing the money.
If credit card debt is a big problem for you and you can’t pay if off with a tax refund there are some other good ways to take control of it. Here’s a short video, courtesy of National Debt Relief, that explains three of them.