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From the time we start working as young adults, we begin to form lifelong beliefs about taxes. One of the most common beliefs is this: “As long as I don’t owe, that’s all that matters.”
Unfortunately, that belief is a myth — and buying into it can cost you a lot of money over time. Here’s why getting a big tax refund by overpaying taxes is a bad idea, and what you should consider doing instead.
How Getting a Big Tax Refund Can Cost You
In order to achieve the goal of not owing the government anything at tax time, many people will intentionally pay more in federal taxes throughout the year. Frequently, we see W-2 forms showing the individual has paid five figures in taxes over the year (for example, $12,000) in order to get a four-figure tax refund (often, around $4,000).
When someone does this, it’s usually because they believe it’s a good tax strategy based on the myth above — but the truth is, they’re shooting themselves in the foot financially. When you’re paying too much in taxes all year long in order to get a large refund, that’s like giving the government an interest-free loan. And why would anyone want to do that?
Calculating How Much You’re Giving the Government
How much money are you giving away by overpaying your taxes? Let’s do some simple math using the example numbers above. In this case, the individual has strategized that if he pays $12,000 in taxes over the year, he will receive a $4,000 refund at tax time. To calculate how much he is giving away to the government every month, we simply divide the refund amount by the amount of taxes paid.
$4,000 refund ÷ $12,000 taxes paid = $333 per month
That $333 is the amount this individual is paying the government every month, for free. The government is not paying him a dime of interest. And the saddest part is, there’s a good chance this person is already struggling to make ends meet.
To calculate how much you’re giving the government every month, simply plug your own numbers into the formula above. The answer to this simple math problem will be the monthly amount you’re giving the federal government as an interest-free loan.
Does the government need your money? For most people, the answer is: “Not as much as I do.” Often, someone who employs the strategy of overpaying taxes throughout the year in order to get a bigger refund is already financially vulnerable. Many are barely scraping by after paying bills and supporting themselves — or, supporting an entire family. For many Americans, $333 can be the difference between:
- Making your car payment vs. falling behind on your auto loan.
- Getting new tires vs. driving on bald, dangerous tires.
- Paying for a repair on your home vs. watching your home deteriorate.
- Buying enough groceries for the month vs. struggling to feed a family.
These examples illustrate the real-life consequences of overpaying taxes in order to get a big refund. If you’ve been doing this, ask yourself: Is it worth it?
The Alternative to Overpaying on Taxes
By adjusting your allowances to pay less throughout the year, you can avoid giving the government an interest-free loan, pay what you truly owe in taxes, and have money to save or invest every month. Typically, we recommend investing that amount in safe, dividend paying stocks that can help you build wealth. One of our favorite services is to guide clients through this strategy.
If you are hesitant to open an investment account, the second best option is to put that amount in a savings account at your bank. If you do this every month as a long-term savings strategy, your money can accrue interest and grow year after year.
For a short-term savings strategy, you can make your savings account a place where you save for emergencies. Creating an emergency fund in your savings account can protect you from getting yourself in a bind when unexpected needs arise.
The Big Refund Isn’t Worth It
“As long as I don’t owe” is not a harmless myth. If you choose your withholding allowances based on this belief in order to get a big tax refund, you’re giving more of your hard-earned money to the government than you should be while also making yourself more financially vulnerable.
At End2End Solutions, we teach clients that the big refund isn’t worth it; then, we help them structure their tax returns in a way that maximizes their financial health. For personalized tax preparation and strategy that’s on your side first, contact us today. We will gladly provide you a free tax consultation.
About End2End Solutions
End2End Solutions is a Southern California financial services company that offers affordable, customized tax preparation solutions for people like you. Our team works year-round to meet the needs of individuals and small businesses who need professional tax service and financial consulting. We provide clients with personalized coaching and other wealth building strategies to empower financial prosperity.
