- Many people celebrate getting big tax refunds, but it’s not necessarily the best financial move.
- The money you get back when you file your taxes is your money – and it could have been in your bank account all along.
- Certified financial planner and Business Insider senior editor Lauren Lyons Cole says the smarter approach is to break even when filing your tax return.
Tax refunds are easily, and perhaps widely, misunderstood.
Though a lot of people see them as a hefty windfall, the truth is the money you get back when you file your taxes is your money. It always was.
And it could have been in your bank account all along.
“I always try to either owe slightly or break even when filing my tax return,” Lauren Lyons Cole, a senior editor at Business Insider and a certified financial planner, told me.
How tax refunds work
Throughout the year, you pay taxes on the money you earn – either by having it withheld from your paycheck or by making estimated payments.
Big tax refunds mean you paid too much in taxes – that you had too much income tax taken out of each paycheck, and now the IRS is returning what is rightfully yours. Instead of keeping your money in a savings or retirement account where it could earn interest all year, you essentially gave an interest-free loan to the government.
A tax refund of zero, in other words, means you optimized your income throughout the year, putting yourself in the best possible position to increase your net-worth.
- Scott Barbour/Getty Images
To increase the chance of getting a small return, Lyons Cole recommends people review and update their withholding status at work to preserve some of their gross income.
She did specify one situation where big refunds can be valuable, however.
If you’re someone who tends to overspend each month, withholding extra money from your paycheck can serve as a natural savings strategy. When you get the money back as a refund, Lyons Cole said it can be easier to divvy up between debts, savings, and expenses than budgeting throughout the year.
Why you might want to owe money
Lyons Cole said she would rather owe money than get a big refund because owing money – ideally just a little – means she was able to maximize every last dollar she earned.
It’s possible to take this approach too far, however. The risk of withholding too little each month is you could end up paying a small fine if you underpay by too much. On its website, the IRS states that few people incur this penalty, and offers guidelines on how to avoid it.
“Make sure your goal is just to get to that no-refund or no-bill kind of place,” she said. “And if you end up owing a few bucks, that’s better than getting a monster refund.”