Getting a big tax refund may not be a good thing
Matt Rourke ap
FILE - In this May 8, 2008, file photo, blank U.S. Treasury checks are seen on more
FILE - In this May 8, 2008, file photo, blank U.S. Treasury checks are seen on an idle press at the Philadelphia Regional Financial Center, which disburses payments on behalf of federal agencies. If you didn't bother filing a federal tax return for 2009, it might be a good time to rethink your tax strategy. The Internal Revenue Service says it has $917 million in unclaimed tax refunds from 2009, and time is running out to claim them. The refunds are owed to nearly 1 million people who failed to file returns for 2009. (AP Photo/Matt Rourke, File) ORG XMIT: WX102 [Via MerlinFTP Drop] less
Eagerly awaiting your big tax return?
Well, according to some experts, your big payday this April may not be anything to take pride in.
"Often the very people who celebrate receiving a refund are those who are most in need of extra money in their pocket each month," said Gail Cunningham, a spokesperson for the National Foundation for Credit Counseling.
According to a February NFCC poll, 56% respondents "plan to always receive a refund each year," compared to just 28% who intentionally plan to "intentionally plan to never receive a refund."
Cunningham points out that a refund of $3,000 adds up to about $250 in extra taxes each month – cash that may make the difference between missing a car payment or bouncing a rent check for many lower-income Americans.
And if you're not living paycheck to paycheck, you're still giving the Internal Revenue Service what amounts to an interest-free loan instead of putting your money to work by paying down debt or investing it so that cash grows.
"Why would you not maximize any asset that could work for you?" asks Chris Woehrle, an Assistant Professor of Taxation at The American College of Financial Services.
Costs vs. Benefits of a Big Return
Of course, Woerhle says he understands why people rely on tax refunds as "enforced savings."
"Most people find it difficult to pay themselves 5%, 10% or any percent," he said. He also added that for those fearing any additional bills, overpaying is preferable to getting a surprise obligation in the spring when the balance of their taxes are due.
But Cunningham of the NFCC says the costs far outweigh the benefits. There are a host of other methods to ritualize saving, many of which are much more flexible than overpaying Uncle Sam and waiting for your April tax refund.
After all, the IRS won't send out the check early if your car breaks down.
Cunningham recommends visiting the withholding calculator on IRS.gov. inputting a little information about your income and family situation, and then adjusting your taxes on form W-4. That will ensure that you don't overpay on your taxes in the current tax year.
As for 2013 taxes, if you're too late to prevent a big refund there are still responsible things you can do with that check.
"The overarching answer is to put the money toward what is putting you most at risk," Cunningham said.
First, catch on bills. "For instance, if you're about to be evicted from your home, or your car is about to be repossessed, use the money to resolve those immediate problems," Cunningham said.
Next, pay down debt. Your "debt utilization ratio" is the second highest weighted element of the credit scoring model, says Cunningham, so having a line of credit near the maximum is a big ding on your credit score. If no account is near the limit, then focus on the highest interest rate or highest balance loan that "is doing you the most financial harm."
Build savings. Most finance experts recommend three to six months of salary saved up for emergencies. If you don't have this nest egg, Cunningham said, you can build one quickly with your tax refund.
Think ahead. Rather than wait for the car to break down or the roof to start leaking, use the tax refund while you have it to perform overdue maintenance on your car or home, Cunningham said.
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Lastly, Do Something Fun!. If all these financial ducks are in a row, Cunningham said, don't hesitate to spend it. "After all, it's your money, the money you worked all year to earn, and Uncle Sam is simply giving it back to you," she said.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor's Guide to Finding Great Stocks.Source: www.usatoday.com