Savings Rates Get a Jump-Start with Tax Refunds
May 17, 2010
In the weeks following tax season, millions of Americans will receive a refund check from Uncle Sam. Research from the American Accounting Association (AAA) suggests that most taxpayers receive refunds, and that this percentage may have risen over time.
Are taxpayers better off getting a refund or having less withheld from their paychecks in the first place? The ultimate answer depends on what you do when you get the money. To decide whether you are better off getting a refund or paying less in taxes from paycheck to paycheck, you should consider the pros and cons of each approach.
Present Value vs. Fiscal Discipline
The argument in favor of lowering your paycheck withholding is that the value of a dollar today is worth more than the value of a dollar a year from now. This is because you can earn money on that dollar over the course of that year, or else buy goods and services before inflation increases their prices. Put another way, excess withholding is like giving the federal government a 0% interest loan on that money.
However, in an economy where bank rates and inflation are both low, this "present value" argument is somewhat diminished. The interest yield you've forgone may be small potatoes.
Besides, people often feel that paying a little extra in withholding imposes some financial discipline on them. A few extra dollars in each paycheck would simply be frittered away unnoticed, whereas a lump-sum refund can be put to more meaningful use.
Where Does the Money Go?
To a large extent, then, the withhold-more or withhold-less argument comes down to what you'd do with a lump-sum refund. A lump sum is a terrific opportunity to revive a savings account or retirement account. Not surprisingly, though, the AAA's research shows that refund checks are not much more likely to go into savings than those extra dollars from paycheck to paycheck. If you're like many taxpayers who receive a refund, you'll most likely be spending that check on the latest electronic gadget or a beach vacation.
The fiscal discipline argument for getting a refund check has merit--but only if you continue that discipline once you get the check.
