Blog My Library Join Roots Now Login

Five Ways Your Tax Return Could Be Hurting You

Did you get, or are you expecting a tax return this year? If so, you may not want to throw your hands up in celebration just yet. Your tax return could be hurting your financial life.

I’ve had the privilege of helping many people get on a plan with their finances. In our membership site, Roots of Personal Finance, we teach our members a very simple process that helps them budget, save, and crush debt for good. While helping these people, I tend to find that many who are struggling and living paycheck-to-paycheck are receiving sizable tax refunds. It’s not uncommon for me to see $1,000, $3,000, $5,000 or even more.

If you’ve been consistently receiving this amount in refunds each year, but are struggling to make ends meet, I want you to consider making some changes that will help you throughout the year.

What a tax refund is and isn't.

The marketing messages about tax refunds have sent mixed messages. Companies do this because they want you to spend your return on their stuff. They also know that most people have no plan for their tax refund, so they send out tons of marketing and promotion to attract you to buy their stuff.

But the truth is that a tax refund is not a reward, it isn’t a bonus or a prize for doing your taxes properly. It also isn’t “EXTRA” money. Extra money gets spent on stuff you don’t need and won’t remember buying a few months later. 

According to investinganswers.com, "A taxpayer gets a tax refund when he or she has overpaid taxes to the government.”

Just like when you buy some new shoes for $45, you’ll give the cashier $60 in cash, they RETURN your change of $15 because you gave them too much money. There is no difference when it comes to overpaying on your taxes. You just gave the government too much of your hard-earned money. 

How could getting a larger refund hurt me though?

If you're giving the government too much money every paycheck, that means that you get less money to help support your financial goals throughout the year. Even worse, if you don’t have a plan for that refund you get, you could easily spend it on impulse purchases making your situation even worse. Here are five ways your refund could be hurting you. 

  1. You can’t save for an emergency fund. Life is going to kick you when you least expect it. But I didn’t need to tell you that. According to a gobankingrates.com survey, more than half (57%) of Americans had less than $1,000 in savings in 2017. This is setting yourself up to carry a lot of debt for life’s emergencies. When you’re living paycheck-to-paycheck and you have nothing left after all of your bills and expenses are paid, it’s impossible to save. Spreading your refund throughout the year will improve your cash flow to save for that much needed emergency fund.
  2. You depend on credit cards to make ends meet. When you're just making ends meet, it doesn’t take much to cause a crisis. Being that we just mentioned that most people don’t have an emergency fund savings, what do most people do? They use high interest credit cards to get by. This is costing you a tremendous amount of money and emotional energy. If you take your refund and spread that throughout the year you, won’t have to depend on credit cards nearly as much, hopefully not at all if you’re following what I teach.
  3. You use your refund as a down payment on a big purchase and go further into debt. Advertising is quickly ramping up with messages of what you could use your refund for. A new car, new furniture, new appliances, or maybe your next vacation. In many cases, your refund may not be enough to cover the entire cost of these items, so many people offset that cost by financing the remainder of the balance and going further into debt. This isn't a good move and you need to think differently. You need to be looking at ways to decrease the amount you owe, not go further into debt.
  4. You can’t pay down debt. If many people can’t save, guess what else that means? They probably aren’t doing a great job of paying down extra on their debt. Just because you have a five-year car loan, or four years left on that student loan doesn’t mean you shouldn’t pay it off sooner. The sooner you pay your stuff off, the more money it saves you in interest. And for many of us, we have plenty of payments on plenty of stuff. Using your refund will help you make a dent in the debt you’ve accumulated.
  5. You can’t save for retirement. Did you see Super Bowl 52? eTrade stated in their commercial that 1/3 of the population isn’t saving for retirement. By the way, this was my favorite commercial from the Super Bowl, you can check it out here. And those who are saving, I'm proud of you! However, based on statistics, many people aren’t saving nearly enough. When you give the government too much of your money, you're giving them an interest-free loan! That means you aren’t making any money and getting any use out of that money as the year goes on. Stop that! Take that money back and start saving it and putting compound interest to work for you!

WAIT! What can I do to fix this?

Check and recalculate your withholdings with new tax laws in 2018. You may be aware that new tax laws were put into place this year. It will be interesting to see how the new tax laws will affect us individually. Currently, many employers are revamping their payroll services to reflect the new tax rates. This may and likely will affect the amount of federal tax you pay. Before you do anything with your withholdings, I would suggest visiting the IRS withholding calculator.

The general idea is to change your withholdings to decrease what you pay in tax so you receive more money on your paycheck. Remember, you're getting a refund because you're giving the government too much money. So when you change your withholdings, you're keeping more of your money in your pocket for you to use throughout the year, rather than getting one lump sum.

TIP: I strongly suggest working with a tax professional to help you determine the proper withholding for your particular situation. Don’t depend on your HR department or even your gut. A tax professional should be on your financial team. I'm a financial coach and I don’t touch my taxes. It’s important to understand them, but I don’t advise you do your taxes on your own. 

Warning: I don’t suggest that you adjust your withholdings to take your entire refund. If you’re struggling, and living paycheck-to-paycheck, owing the government isn’t going to help your situation. Again, this is why I strongly suggest working with a licensed tax professional to help you.

“I love my tax refund!” Have a plan!

You might be like some of the people I work with who love their tax refund. For many, a tax refund is a form of forced savings. I understand that because having success with money is 80% behavior! If you change your withholdings giving you more money like the tip above suggests, but you find yourself dining out at more restaurants, or standing in line at Target more often, that might make your situation worse. If you have a spending problem, you need to consider fixing it before you allow yourself access to more money. 

Another option is to have a plan for your tax refund. If you're getting a sizable amount of your money back, open a separate savings account and deposit your refund into the account. Then, draw on that money monthly to help your cash flow. For instance, if you're getting $3,500 back, you could adjust your withholdings. Let’s say you adjust them to withhold $2,400 of your $3,500 refund, you could pay yourself $200 per month every month for the entire year to help build your emergency fund, save for retirement, or pay down debt. The key to having success with this is behaving and having the discipline to keep that money in there to help you throughout the year. 

“It’s payback time! Spend your tax refund on new...” - NO!

As I mentioned, every retailer is out for your refund. They know that most people don’t have a plan for that money and they will use every trick in the book to get you to spend it on their stuff. You have to play defense. That tax refund money can be a saving grace for many people, but you have to use it properly to get the benefits. Ignore the marketing, make a plan, and your savings account and future will thank you! 

If you implement these tips, your tax refund will be more likely to help you save money, pay off debt, and improve your financial life!

Close

50% Complete

Do Your Finances Make The Grade?

Enter your name and email address to take your assessment! You will not be asked any personal financial information.