Tax Musings of a Burbank CPA: So Why Can a Big Income Tax Refund Be a Bad Thing?

Well you have filed taxes for this year and are getting a big refund.  What to do with this windfall?  How about kicking yourself.  You do realize that a “tax refund” is made up of two parts – you give your federal or state government YOUR hard earned money throughout the year and when you file your taxes, said government gives you YOUR money back.  Effectively you are letting the government have it interest free for the year (so it gets the ‘float’ on the money!) then returns it to you.  You are hiding your money under the IRS mattress (except you don’t have access to it.) 

Here is another idea.  Say you get approximately a $4000 refund every year when you file your taxes.  What would happen if you reduced your withholding $250 a month and put that into a savings account paying .75% a year.  That means you have $3000 in the bank with about $15 interest by the time you would get your $1000 tax refund on Feb 28.  Doesn’t sound like much does it?  Well what if you put the money into a mutual fund paying about 5% a year in dividends?  Now you have $100 in dividends by the time you get your refund.  Now do this each year for 10 years.  Instead of $40,000 (which you probably spent most of) you have $10,000 in cash and almost $39,000 in your investment account.  So just taking the money early would have made you $9000 in ten years instead of the government, thanks to compounding your money.  Or you can keep giving your money early to the government and let them compound it before returning the original money to you.

Think about this – it is your money, after all.

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