A large tax refund may seem like a financial windfall, but is it the smartest way to manage your money?
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GOBanking Rates asked the experts. While some financial experts said a lump sum could help taxpayers save or pay for financial emergencies, others said it could mean missing out on opportunities for financial growth throughout the year.
“Getting a large tax refund first means you overpaid your taxes, which means you won’t pay any underpayment penalties,” said Jake Skelhorn, partner and wealth advisor at Spark Wealth Advisors, LLC. “If you have any high-interest debt, a big refund can be seen as a benefit if you use it to pay the debt off.”
Here are the pros and cons of getting a large tax refund. Is it worth it?
Pro: A Financial ‘Windfall’
Many taxpayers who receive a large tax refund consider it an annual windfall or “forced savings.”
“It may be tempting to use the refund for large purchases or a family vacation,” said Joe Buhrmann, a senior financial planning consultant at Fidelity’s eMoney Advisor. “For many Americans, this is one of the largest infusions to their cash flow during the course of the year.”
Buhrmann explained, “With financial tensions running high for many Americans as a result of home prices, inflation, interest rates and talk of fiscal policy changes, it might be beneficial for individuals to pay down consumer debt or shore up shaky emergency funds.”
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Con: You’ve Overpaid Your Taxes
A large tax refund also means you’ve overpaid your taxes throughout the year.
“You’ve provided the government — federal or state — an interest-free loan of your funds, money that may have been more impactful to your cash flow throughout the course of the year,” Buhrmann said. “The biggest downside is that you — as the overpaying taxpayer — didn’t get the use of those funds throughout the course of the year.”
Overpaying one’s taxes could mean not being able to make smart money moves during the year.
“Many might feel that they could make a better choice of what to do with an extra $100 or more in each paycheck than the federal government could do,” Buhrmann said. “A few extra dollars in each check throughout the year might allow additional funds to be set aside for retirement, education funding, building cash reserves or providing additional insurance protection.”
Pro: No Surprises
One advantage of receiving a large tax refund is no surprises when you file your tax return.
“You already paid enough, in fact, more than enough through your paycheck withholding throughout the year,” said Logan Allec, a CPA and owner of Choice Tax Relief.
Allec said, “Those who benefit the most from a big refund are those who may not have the ability, time or discipline to accurately calculate exactly how much in taxes they should have withheld from their paycheck. For these folks, it’s probably better that they err on the side of caution and get a large tax refund.”
However, Allec said taxpayers who can accurately calculate their precise tax withholding amounts and are disciplined enough to use the extra money in their paycheck wisely should avoid getting a big refund.
It Depends
Taxpayers who receive a large refund could miss out on financial opportunities that could have shifted their money mindset and yielded better results.
“Chances are that inflation may have reduced the purchasing power of your refund,” said Aaron Razon, a personal finance expert at Coupon Snake.
Nevertheless, Razon said individuals who struggle with saving money and those who face financial difficulties could benefit from getting a large tax refund.
“For individuals who find it difficult to save, receiving a large tax refund can be a great way to build the momentum to save,” Razon said. “While those who are facing financial difficulties would benefit from a large tax refund, because it allows them to pay off high-interest debts and regain their financial stability.”
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This article originally appeared on GOBankingRates.com: The Pros and Cons of Getting a Large Tax Refund — Is It Worth It?
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