Every year, as the calendar pages flip toward April, a certain buzz fills the air. It’s not just the promise of spring but the anticipation of tax refunds. There’s a common belief, almost a financial folklore, that getting a big tax refund is akin to hitting a mini jackpot. But here’s a hot take from a seasoned financial planner:
Getting a big tax refund is not necessarily a good thing.
Let’s debunk some myths about the big tax refund, talk about why it’s not as great as it sounds, and what you could do instead that will actually earn you big money.
The Myth of the Big Tax Refund
If you’ve ever gotten a sizable tax refund, you’ve probably experienced an odd sense of pride about it. Like you outsmarted the government and got a bonus check to show for it. While I don’t want to rain on your parade, we need to acknowledge the reality of the situation: the money you got back is your money. It’s just being returned to you, interest free, because you overpaid the government all year, forgoing access to your own money in the meantime. It also means that your tax planning strategy – a plan that allows you to pay the lowest taxes possible – isn’t working as well as it could. Imagine giving someone a loan with a zero interest rate and celebrating when they finally return it. Doesn’t sound quite right, does it?
There’s an allure to getting a big check seemingly out of nowhere, even when we know what it really is. What we don’t tend to think about, however, is what that money could be doing for us instead of sitting in the government’s coffers.
Having access to that money throughout the year could make your cash flow system work more smoothly, for example. You could also invest those funds or earn interest on them.
Don’t Judge Your Accountant's Performance by the Size of your Refund
Another common myth about taxes is that a big tax refund means your accountant is doing a great job or your tax planning strategy is successful. This couldn’t be further from the truth. A more accurate measure of a good tax planning strategy is how close you can come to breaking even – minimizing both what you owe and what you get back. This approach ensures you’re making the most of your income year-round, not just when tax season rolls around.
The Flip Side: Owing Money
On the other hand, if you find yourself with a large tax bill after filing your taxes, it’s a sign you need to make some adjustments to your tax planning strategy. A large tax bill could mean not enough was withheld from your paycheck or that a large bonus or taxable event wasn’t accounted for properly. It’s crucial to monitor these variables throughout the year to avoid surprises. Regular check-ins with your tax planner or accountant about your tax planning strategy can help you navigate changes and adjust withholdings accordingly.
A Proactive Tax Planning Strategy means No Surprises
We have a motto when working with clients on tax planning strategy: No surprises. Sitting down with your planner or accountant to review the upcoming year’s potential tax scenarios can make all the difference. Understanding what you might owe (or get back) and planning for it sets you up for a financially healthier year. This is about optimizing your finances so you can do more with your income throughout the year, like investing, saving, or paying off debt. It also may mean some smart tax planning opportunities are available to you given your situation like making sure you’re deducting all the expenses you can or maximizing how much you can save in tax deferred accounts. More on that here.
The allure of a big tax refund is understandable, but it’s time to shift our perspective toward smarter financial health. By adopting a proactive approach to your tax planning strategy, you’re ensuring your money works for you all year long. Let’s leave the surprise tax refunds and large dues in the past, and plan for a future where we know what will happen with our money. After all, good financial planning is about making informed choices with all the money you’ve worked hard to earn, not just celebrating a once-a-year payday from the IRS.
Jim is a financial advisor and owner of Thinking Big Financial, Inc. Thinking Big Financial is a fee-only registered investment advisor offering financial planning and investment management services. Specializing in working with the LGBTQ Community.
Please read my legal disclaimer here.