Is Your Tax Refund an 'Interest-Free Loan to Uncle Sam'?
The first tax refunds will go out in mid-February, and millions of Americans can't wait to get that money. Last year, the average refund was about $2,700, the IRS reports. That's more than a month's income for two out of three taxpayers or more than three months worth of groceries for a typical family of four, according to TurboTax.
"The tax refund is a significant financial windfall, the biggest financial payday for most Americans," said Bob Meighan, lead CPA for The American Tax & Financial Center at TurboTax. "People plan for and look forward to those refunds. It's critically important to them, especially people living paycheck to paycheck."
How will people use this refund money?
"Surveys show the majority of the people who receive a tax refund will do smart things with it, such as pay down debt, make planned purchases or build up an emergency savings account," said Paul Golden, media relations manager at the National Endowment for Financial Education. "So having that tax refund can be a useful financial planning tool for some."
A TurboTax survey found that 29 percent of those getting a refund planned to add it to their savings or retirement accounts. Another 24 percent would pay down debt; 16 percent said they needed the money to pay for living expenses.
"It's probably one of the only and best forced savings mechanisms for many low-income households because it does allow them to save without compromising on their regular take-home pay," Meighan told me. "They're able to get by as it is, so this windfall really does help them in terms of managing their money."
Is overpaying your taxes a smart way to save?
If you're good at sticking to a budget and can pay your bills on time, don't have expensive credit card debt and have the discipline to use that wisely, this might make sense.
Just remember, that refund is really an interest-free loan to Uncle Sam. It's money you could have during the year to pay bills and reduce credit card balances.
"If you are scrimping to get by and piling up debt throughout the year, but getting a large tax refund every spring, adjusting your withholding to get more money in each paycheck is a better way to go," said Greg McBride, senior financial analyst at Bankrate.com. "It will ease your financial burden and reduce your stress throughout the year."
And consider this: If your refund is $2,700, you could have about $225 more each month in take-home pay by adjusting your withholding.
"An extra $225 is a small fortune to many people we see," said Gail Cunningham with the National Foundation for Credit Counseling. "It can be the tipping point between financial stability and financial disaster, the car being repossessed or not, missing the rent or paying it on time."
As of Jan. 1, the Social Security payroll tax rate went from 4.2 to 6.2 percent, so your paychecks are going to be slightly smaller. Cunningham said people who are "living on the financial edge" need to adjust their budgets or their withholding to deal with this. The IRS has an online calculator.
IRS delays filing date
Because of the last-minute deal to avoid the fiscal cliff, the IRS won't start taking tax returns until Jan. 30, eight days later than had been planned.
But you don't have to wait to prepare your taxes. If you use tax-preparation software, the vendor probably provides secure storage until the IRS opens its doors.
"It's first in, first out, so we're encouraging people not to delay filing simply because the IRS has delayed their processing," said Bob Meighan with TurboTax. "About 85 percent of all filers will be able to file on Jan. 30."