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Monday, June 4, 2012

Tax refunds: when bigger might be better

Theoretically, you want to minimize your tax refund by claiming the correct withholding on your W4 so you can invest that money throughout the year instead of letting Uncle Sam keep it interest free. However, there are times when it makes sense to keep getting that large refund and not claim all your allowances to help reach your financial goals.

First things first: I am a huge proponent of claiming the correct withholding on your W4 so that you can make your money work for you instead of getting an interest free refund every year.

But I also want to get real. I was reading an article on Identity Theft where thieves were filing tax returns and then getting the refunds. Many of the victims are people that count on their tax refund every year. While the ID theft story was interesting (and frightening), the realization for me was that these folks are getting thousands of dollars back and this is truly a great saving vehicle for (some of) them.

For those of us that claim the correct allowance on our tax withholding and are diligent about saving that extra money, that's great, and the financially proper thing to do. On the other hand, there are folks that are not claiming the correct allowance, getting huge refunds, and then blowing it at the casino or on something that they can't afford. Then, there are the people that just can't seem to save monthly for whatever reason, so they purposely claim a low allowance to ensure the largest refund possible, and they use that as a savings vehicle. While it doesn't make as much financial sense to save your money this way. its the only way some people will save at all. So while they may not be receiving interest throughout the year, once they actually get the money, they might throw it in a CD or pay down their mortgage which is financially smart.

The Takeaway
You will get the most bang for your buck if you claim the correct withholding on your W4 (see this post for more info) and then invest your extra cash monthly in some sort of savings vehicle. If you blow your refund habitually- minimize the refund; your personality style would be better suited to getting more in each paycheck and setting up a automatic savings plan. However, if you know yourself and your habits, and you know that you just can't seem to stick with a consistent savings plan month to month... by all means, wait for that large refund, as long as you are smart with it. In this scenario, if you fail, don't  keep try, trying, again year to year and lose out on valuable time to save some green. Just do what works.

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