The Downside of Tax Refunds

Every year the story seems to be the same — the Internal Revenue Service is paying out more and more to taxpayers in the form of refunds. Most of us like to receive a refund, but you have to wonder why. After all, a refund means we paid too much to the government in the first place.

What's more, if we overpaid the government, we don't earn a dime on the investment. As long as we claim it, the government pays us back months later, but at a 0% interest rate.

There's a better way
In early April, the IRS estimated the average refund on 2001 tax returns equaled $1,954, a 12% increase over the average refund in the previous year.

That means too many of us are having too much money withheld from our paychecks. The average refund amounts to about $160 per month.

A better approach is to adjust the amount withheld on your paycheck. You can do this by filing a new copy of IRS form W-4. Ask your employer how to make this change.

The next step — pay yourself first
So if you can adjust your withholding to put extra money in your pocket each month, what should you do with it? It may be tempting to spend those dollars, but a better option may be to pay yourself first. Set up an automatic deduction from your bank checking account to invest the money in a variable annuity or other investment option.

This way, you can actively put the money to work for your future. After all, what's more important than to do as much as you can today to realize your ultimate financial goals?

What impact could that have? An additional $160 per month invested over 20 years and earning an average annual return of 9% would result in an additional $107,663 for your portfolio. All that just by investing a little more than $5.00 per day that you could be overpaying in withholding taxes right now.

Take a careful look at your tax return, and try to figure out a way to put your own money to work for you, rather than paying too much in taxes. Just be certain you don't under-withhold from your paycheck, as you might find yourself subject to a tax penalty.

Content is for informational purposes only and may not accurately reflect your specific situation. Information is not intended to provide financial, legal, tax, or accounting advice. You should consult a qualified advisor for advice specific to your own circumstances.