Why a Big Tax Refund Can Actually Be a Bad Thing for Your Money

Reducing your tax refund to keep more money in your paycheck could help you grow your savings and investments faster. Here's how to do it.


One way to make your tax refund work harder for you is, counterintuitively, to reduce it.

Why? A giant tax refund isn’t free money—for you.

“If you’re getting a refund, you’re in essence giving the government an interest-free loan,” points out Melissa Labant, director of tax policy and advocacy for the American Institute of Certified Public Accountants. That’s money you could have had in your paycheck throughout the year.

Still, many people look at tax refunds as a kind of forced savings, she says—a lump sum they can’t touch until tax time but can then be used for any number of smart money moves. (Check out our guide on making the most of your refund, here.) That’s not a bad idea if you’re struggling to save year-round. And it’s certainly preferable to having a surprise tax bill.

But there is a price tag. If your plan is to save or invest your refund, the difference in timing—making one big deposit at tax time versus a smaller one with every paycheck—adds up.

Let’s say you got a $3,000 tax refund. (That’s about average from last year.) If you get paid every other week, that works out to about an extra $115 you could have in each paycheck.

If you set up automatic contributions into a high-yield savings account earning 2 percent, those recurring $115 deposits would add up to $3,020 over the course of a year. In an investment account with projected returns of 5 percent, you could end up with $3,062. That extra $20 to $62 is the cost of your interest-free loan to the government.

It doesn’t sound like much, but over time, the effects of that compounding start to build.

At the three-year mark, someone who steadily saved $115 per paycheck would have about $70 more than someone making a single annual deposit of $3,000. The more frequent investor could have an extra $202. (Those numbers assume the rates of return hold steady, and that you don’t touch the money in the account—neither of which is especially likely.)

So how do you go about reducing your refund to keep more in your paycheck? Adjust the amount of federal tax your employer withholds from your paycheck.

Doing so is easy, says Labant. You’ll just need to fill out Form W-4, and turn it in to your employer’s payroll department. The form includes worksheets to help you estimate the right amount, and the IRS also offers a calculator to run the numbers.

Set a calendar reminder to revisit this task later in 2019, Labant says. Some of the worries about smaller refunds this year stem from changes the IRS made last year to the guidelines employers use for withholding. Now they’re planning to make yet another round of adjustments and update that Form W-4, Labant says—which could affect what your tax situation looks like next year.

“I would recheck that [withholding] number in about six months,” she says.

Here are some other key takeaways from this week to help you grow your knowledge:

Smooth out investment bumps. Grow contributor Bob Sullivan offers up an explainer on how a smart investment strategy called dollar-cost averaging works. It can make you feel calmer about market bumps—and grow your wealth.

Waterproof your insurance policies. Some forecasters say spring flooding could be especially bad this year—and it’s one disaster that your typical homeowners or renters policy doesn’t cover. With that in mind, now is a good time to look over your home and auto coverage.

Plan out summer child care. Summer vacation is months away. But it’s not easy for working parents to coordinate a summer’s worth of quality, affordable camps or other care for their school-age kids. Start now—when there are early-bird discounts, camperships and other deals available.

Snag valuable tax breaks. The new tax rules make it more likely you’ll take the standard deduction this year. Grow contributor Marianne Hayes has the scoop on moves you can still make to reduce your tax liability, as well as other credits and deductions you can stack.

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