Tax Refunds vs. Correct Withholding: Which Makes More Sense For You?

You’ve heard all the hype about income tax refunds. People love them, look forward to tax season because of them, use them for vacations, for big purchases, or to pay off debt. It’s like another savings account, they say – a nice boost each year.

But what does it really mean when you get a refund from the IRS? It means that you’ve been allowing good old Uncle Sam to dip into your paycheck a little too much each pay period. Wouldn’t you prefer to have gotten that money as you earned it throughout the year, and not have to wait for the government to give it back months later?

There are pros and cons both to setting your withholding amount so that you receive a refund, and to changing it so you don’t. But for the most part, it depends on your spending habits and preferences. Let’s take a look at a couple of the factors that might determine which choice is right for you.

Paying Off Debt

One reason people often give for wanting a nice big income tax refund is that it gives them the opportunity to pay down their debts. And we’ll admit, it’s definitely more satisfying to put a couple thousand dollars towards a credit card all at once, than to chip away at it slowly with smaller payments.

But when you take interest into consideration, you’d actually get your debt paid off more quickly if you had a little extra money in each paycheck to put towards it each month. If you know you have the discipline to do so all year, then that’s the better option. If you worry you might end up using those extra funds for other things, then the refund may be the way to go.

Savings Accounts

Another reason people prefer refunds over correct withholding is that they can take that nice big sum and put it in savings, or invest it – and in fact, they feel that allowing the IRS to hold a little extra from each paycheck functions like a savings account, too, with the payoff of the refund each year. While that ‘out of sight, out of mind’ mentality is definitely helpful in saving – the money is gone before you ever even receive your paycheck, so you don’t really miss it – there are plenty of other ways to save that take the same approach, but can actually be earning you interest all year, too.

By setting up automatic withdrawals into an interest-bearing savings account, or asking your employer to direct deposit part of your pay into savings each pay period, you can duplicate the ease of saving, but keep your money working for you. Again, however, if you worry you’ll be temped to dip into your savings throughout the year, then the bank of Uncle Sam may be your best bet after all.

Basically, it all boils down to knowing your own spending habits. If forced savings is the easiest and most secure way for you to accomplish your financial goal, then by all means, keep those refunds coming. But if you’d rather keep control of your own money all throughout the year, then you may want to take a look at your withholding, and see what you can do to make the change.

Whether you prefer a big refund or bigger paychecks, E-file can help you make the most of every deduction and credit you have coming to you. And who knows? You may just find that you qualify for a refund even after adjusting your withholding. Let E-file help you find out.