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Jan 23, 2019
9:01:14am
garyfan All-American
Before we get too far into tax season, and before people start pounding their
chests about how they didn't make an interest-free loan to the government, let's put this issue in its proper context.

If the choice is between either (a) larger withholdings and a $10,000 tax refund at the end of the year, and (b) smaller withholdings (e.g., getting slightly larger paychecks throughout the year) and no refund or taxes due at the end of the year, of course it makes more economic sense to pay yourself a bit extra every paycheck. Getting money now is better than getting money later. We all get that point.

But now for the context. If that extra money is going to sit in a savings account (which it likely would) earning 1% interest, the extra income would result in a whopping $50 by the end of the year, or $4/month. Very inconsequential. And that's assuming a $10,000 refund, which is larger than what most people would be dealing with.

Wait, but instead of earning 1% in a savings account, the money could be used to reduce debt (avoiding interest) accruing at 5%! Ok, so the $50 estimate from above becomes 5 x $50 or $250 per year. And it would be even less if the money is used to pay off tax-advantaged debt (like a mortgage). And again, that's assuming a $10,000 refund is the alternative, which far exceeds the refund most people are in a position to get. If we assume a more realistic refund of $3,000, instead of $250 in annual savings, we're talking about $75 in annual savings, or $6/month, even if the monthly savings are immediately used to pay off debt accruing at 5% after-tax. Whoop-de-doo.

Don't get me wrong, I'd rather have than not have $75. But this issue generates far more hand-wringing and back-slapping than it deserves, especially when you consider all the other ways people waste $6 in a month.

So if you have some non-economic reason to prefer a larger refund (e.g., you really want to avoid writing a check at tax time, or if it just feels more like a happy surprise to get a large refund than to watch the savings account slowly build, or you're just more likely to do something fun/productive with the refund money than with the slow trickle of savings every paycheck), more power to you.
garyfan
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garyfan
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1/23/19 9:04am

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