Is Getting a Large Tax Refund Bad?

Dan writes in with the following question regarding tax refunds and withholding:

I am a married sailor with two kids. I still have taxes taken out as though I were a single man. The reason I do this is because I lack the discipline to handle the extra money each pay check. It’s kind of nice to overpay every year and get the lump sum back from the government. Then my wife and I pay down some of our debt and move on. We don’t splurge with this money.

I’ve been told many times that I’m just giving the government an interest-free loan and that I should pay more down on my debt each month instead of once a year, but I’d like to get your thoughts on this.

There have been many debates about the practice of withholding too much in taxes to receive a large refund at the end of the year. I tend to agree with others who have advised that this is sort of like allowing the government to use your money, tax free, throughout the year and then return it to you at the end of the year.

A better way to think about it is to examine the opportunity costs associated with getting a large refund. Let’s assume your tax refund last year was $6,000. That works out to about $500 a month too much in taxes withheld from your pay.

If you dropped that $500 a month in an online savings account averaging a 3% yield, you’d have $6,100 after the first year. That’s $100 you’re missing out on each year just by having the government hold your money. But that’s not all.

If you used some or all of that money to pay down debt throughout the year, instead of waiting until the end of the year, you would likely pay less in interest charges, too.

There is also the issue of security. You didn’t mention an emergency fund in the mix, but this $500 a month would go a long way towards building a buffer between your family and the next financial emergency. If that same money is tied up in taxes, you won’t see it until February, and it won’t be available to help cover those inevitable expenses all households experience.

Having said all of that, I can appreciate the idea of using taxes as sort of a “forced” savings account. Often times we have to use things like this to protect ourselves from ourselves. If you will likely blow the $500 a month instead of socking it away, or using it to pay down debt, then over-paying taxes throughout the year and counting on a big refund might make sense. Still, I’d look for a way for you to control that money yourself and get some benefit from it.


  1. I’ve been in many debates about this and I’m sure you’re going to get people screaming from both sides. Here’s the thing: if it works for Dan, keep on doing it.

    Is it an interest-free loan? Sure it is. Is it better than spending it on something trivial? You bet.

    Whatever method of saving works for him works for him. There is no point in telling him he should do it differently to get $100 in interest if he just won’t do it.

  2. I understand you point FrugalDad but like Dan mentions, he likes receiving the lump sum at once. He budgets based off of what he gets and considers this a bonus. $100 a year would be nice but the reality is it isn’t looked at like that and the one lump sum is a nice bonus essentially. that’s how I look at it and use it to add to my Roth or vacation fund of some sort.

  3. I overpay my taxes and get a refund, for a few reasons, but it boils down to it being easier to do this than to convince my (wonderful lovely couldn’t live without her) wife that we could put the money away ourselves without wasting it.

    Early in our marriage we got hit once with needing to send money to Uncle Sam at tax-time, and since then she’s been paranoid.

    Is it an interest-free loan? Sure. But we budget based on take-home pay, and use our refund each year for something we didn’t budget for: something that improves the home, a trip to visit family members out of state, a major car repair, etc. If we had active consumer debt it would be a different story….

    It works for us. I’d like to experiment with changing it, but some battles aren’t worth fighting — the net gain isn’t worth the emotional stress :).

  4. Despite the fact that I claim “Married and 10,” I generally get a good sized refund each year because of the medical expenses associated with my daughter’s condition. I try to figure it so that it’s just right, but those deductions always seem to pop up. At the beginning of the year, who knows exactly what medical expenses you’ll incur? As a result, I STILL get a refund, but I’ve used them in the past as a “debt avalanche!” This year will be no different but I’ll be using this year’s refund (for 2009 taxes) to fund my Roth IRA.

  5. I would rather overpay and get a larger refund than not pay enough and have to scrounge around for the funds to pay taxes owed. Usually, we get refunds, but unfortunately, my hubby was laid off in October and we didn’t have enough deductions so we owed around 1800. Not a lot of money, but when you are already down to one paycheck and a partial paycheck from unemployment…it’s not easy to find an extra 1800 in the budget. I’d rather overpay and receive a $10 refund than have to go through that again.

  6. I used to say “whatever works for you” as a strategy, but consider the state you live in before you do this kind of thing.

    With states like California going issuing IOUs last tax year, are you 100% sure when you’ll get your money back? Instead of an interest-free loan, you may find it becomes an interest-free extra-long loan? How long are you willing to part with that money?

    If you’re still comfortable handing your money off into this defacto savings with the assurance that eventually you’ll get it back, or if you think your state can handle it (some are doing better than others), then go for it.

    Just remember that this isn’t 4 years ago.

  7. I agree with those who’ve said: “if it works for him, do it.” It’s way too easy for the mathematical geniuses we frugal folks are to nit-pick his decisions like some Monday morning armchair quarterback.
    On the other side, I fear a little for Dan’s long-term financial success. If he can’t muster the discipline to contact his pay office and ask them to withhold an extra $xxx dollars and send it to an online account, he’s going to have a hard time saving for anything. I would encourage him strongly to look toward some kind of financial counseling for himself and his spouse. If you want to start out on the cheap, try looking for advice online like Dave Ramsey’s website. I know a few days ago on this site there was a post about 5 reasons the author DISagreed with Ramsey, but overall Ramsey’s methods are pretty solid and great way for beginners to start taking control of their financial well-being. His philosophy is more geared towards the emotional side of dealing with money rather than just the number crunching that we frugal geeks get our kicks with. And that sounds like what Dan needs: basic, down-to-earth, no-frills training on how to deal with money.
    I’m a National Guard member (13 years) so I know that there is a great plan called Thrift Savings (sort of a 401K for the military). It’s easy to just call them and say, “Please take $300 a month out of my check and deposit into my account”. The bad is that it’s locked away until retirement. The good is, of course, that just like the Uncle Sam tax bite, you never miss it. Then at retirement (gotta love the 20 year deal with the military), you still have a pretty decent pension, so it’s not like you’ll never see any money until you’re age 60.
    So, to sum up, I’m glad Dan is reaching out for some advice. Mine is to get some counseling and training because there is a need to have financial discipline. Also, remember that several states this year WITHHELD income tax refunds that were due (California, Missouri, etc). How will you feel if next year instead of your big fat refund check you get a big, fat IOU? Take charge, brother, it’s your life and your money.

  8. Mrs. Micah makes a great point for anybody in the state of California, which is essentially trying to coin its own currency.

    Aside from that, this is yet another discussion debating mathematical superiority vs. influencing human behavior. I don’t think it’s that big of a deal to overpay your taxes a little and then get a “windfall.”

    I’d be more concerned with Dan’s specific circumstances. When he says he uses the large refund to “pay down some debt” is he talking about paying extra mortgage principle (good) or is he talking about just temporarily lowering the recurring balances on credit cards, and then going shopping and charging them right back up?

    The answer to this question is far more important than his tax withholdings.

  9. This isn’t sort of like allowing the government to use your money, tax free, throughout the year – it is EXACTLY that. You’re giving the government an interest-free loan. Would that they were generous enough to do the same for you!!

    Many (most?) employers offer options to draft a set amount right off the top of your paycheck and deposit it into a savings account twice a month. There you have it – no self-discipline needed.

    We underpay throughout the year and set back enough to cover the hit come April. Mostly we do this just because it makes financial sense to do so. But while it may seem a bit petty & spiteful, there’s also a itty bitty part of me that takes great joy in knowing that I’ve denied the government the opportunity to snatch any more than absolutely necessary of my hard-earned dollars.

    I’m with the others here who’ve cautioned that you could be setting yourself up for little more than an IOU instead of a tidy refund. Bail yourself out rather than the fat cats!

  10. Thank you all for helping me with this issue. I appreciate the thoughts as they are all very helpful. I like the idea of getting the extra money per month and doing productive things with it, so perhaps this is something to consider. That’s all I’m promising though…

    And for the writer above, this is bad debt…mistakes of my past are still hanging on, so we’re getting rid of them.

  11. “And for the writer above, this is bad debt…mistakes of my past are still hanging on, so we’re getting rid of them.”

    I think you’re referring to me, also an ex-sailor BTW.

    Anyway, as long as you now recognize that they were mistakes and are getting rid of them, you’re doing great.

    If this overpay-taxes-for-a-big-refund method works for you, that’s fine, keep it up. And every year do something really positive with the money; pay off the bad debt for now. If, when all that debt is gone, you think you might be tempted to just blow the refund, then put it toward your mortgage balance instead.

    Good luck.

  12. If I were in debt, I would prefer that $$ monthly go towards paying down the debt, and lessening the amount of interest paid on the debt by paying monthly rather than once a year.

    It’s MY money, not the government’s – and I prefer to hang on to it til 4/15 when I reluctantly send off the balance due.

    I agree with forced savings – automatically. Set up a withdrawal at your local bank from your checking to savings if you are saving up for property taxes, etc.

    But in the end – if it’s the ONLY way he can pay off debt, then by all means go for it. It’s not the most effective way, but it’s better than nothing 🙂 To each his own 🙂

  13. Way to go, Dan! It’s great that you’re nailing down the debt.

    A person has to compare the benefits of two possible strategies, but they have to compare the risks too.

    From a benefit standpoint, holding onto your money beats getting a big tax refund because of the opportunity cost. But the trouble with opportunity cost is that it’s imaginary. It assumes the best possible state of affairs. The no-tax-refund strategy assumes some things:

    – you have access to investments that can produce significant returns that aren’t eaten up by transaction or maintenance fees
    – you will direct every cent to these investments or to debt repayment, instead of spending the money
    – your other income is stable and more than sufficient to cover all your needs and most of your wants, such that you’re not even tempted to touch the money for any reason
    – you have no morally “better use” for the money (such as paying for a loved one’s life saving surgery)
    – you can set this money aside without hurting someone you love, who might be pressing you to give the money to them or to use it for another purpose
    – the investments you select will make money and not lose money (meaning you’ve done enough research and spend enough time watching the investments to pick good ones, and you’ve been around the tree enough to tell good advice from bad), and
    – you don’t need to liquidate an investment before it’s ready to sell and it’s achieved maximum growth (which means, you don’t need the money for an emergency fund or for a child’s college tuition because you’ve funded these things separately) and
    – you’ve got some kind of hedge against bad market conditions

    These conditions just don’t apply to most middle class people. Two or three might apply to the average family, but not all. Everyone else is *far* too vulnerable to short term market changes.

    If you had two people with the same income and deductions, and if one held the money back and bought stock all last year while the other one let the government keep it, after the big stock slide this spring the forced-deduction saver would be ahead of the investor. The gradual investment strategy only reliably pays off in the long term. In the short term, stocks, bonds, and mutual funds can and do lose money. This is why I don’t believe stock, bond, or mutual fund investment is a good idea for someone who’s going to need the money within the year (say maybe to pay off debt).

    It’s true the chances of the government deciding to not issue a refund are higher now in some states. Yet compared to the chance of losing money in the stock market, plenty of people still consider the government a better risk.

  14. I aim for getting just a small refund. I do not want to delay any significant cash flow for up to year because I have better things to do with my money than have it held in the government coffers until the next spring. That said, I do attempt to have things set up so that we receive around $1,000 as a refund. This is simply a buffer in case we end up owing a bit more in taxes than planned. I just do not want a surprise come tax time when we find out we actually owe some money.


  15. Dan,
    If this works for you, keep doing it. Don’t let anyone else tell you what’s best for you. And don’t feel that your all alone; lots of people do this. Better they owe you than you owe them.

  16. Personally, I would not intentionally opt for the large refund.

    If something happened today and I need some money, waiting for a refund would seem like forever. And as Mrs. Micah points out, the money may sometimes be delayed.

    But, what works for me may not work for someone else. We should do with works for us, not for someone else.

  17. I used to be of the same opinion as sailor Dan, that it was nice to get a chunk of money back and use that to pay down debt. But the points that FrugalDad makes are more than valid. The only reason I haven’t changed my withholding from 0 is the wildcard of freelance work throughout the year, and the dreaded 1099s. For me, it’s a buffer. For others, I would suggest they take it and invest it rather than have the government hold onto it.

  18. When I worked for an employer, I’d have them withhold at single 0, and used the tax refunds as my savings account.

    Now that I’m self-employed, that’s not an option. There are no withholdings. However, I have yet to make enough to have to actually worry about that. Last year, I made just under $10,000, and as a single mom, I qualified for the Earned Income Credit. Also, I had bought a house in October of last year, qualifying me for the First Time Home Buyer Credit. Between the two, as well as the other various credits, it more than covered my self-employment taxes, etc., and I STILL got a HUGE income tax refund.

    I completely understand where Dan is coming from. I have a hard time saving. I live, literally, week to week. One week, I might have an extra $50 to put in the bank, and then the next week, I’m short $50, and that money comes right back out the bank. Having a high withholding rate is a buffer against that. You budget as if that money never existed, because for you, it really never did. And when tax return time comes, you cover debts, catch up any late payments, and buy any big ticket items you might have been holding off on throughout the year.

  19. It is possible to change your withholding/exemptions on your W-4 during the year. I underwithhold the first half of the year and then overwithhold during the last half of the year. In the end, I break even or owe a few hundred dollars.

    My primary concern in the next tax filing season is that “IOUs” instead of “refund checks” will be issued by more states like Kansas and California did this past year. It’s sad, but governments don’t see your tax refund as your “savings account”. They see it as a over-budgeted outflow/expenditure. Kansas and California were pilot states that experimented with “IOUs” and deferring tax refunds. With many state budget deficits, the number of states issuing IOUs will increase dramatically next tax filing season.

    Now is the time to change your withholdings and keep the “automatic raise” in a savings or interest-bearing account. Remember…underwithholding of tax is not penalized unless you owe over $1,000 [Some state thresholds are lower] as long as you pay up by April 15 of next year. I think that a “forced savings” account with Uncle Sam is an excuse not to be financially disciplined. Don’t open the door for an opportunity to be served an IOU instead of an expected tax refund.

  20. @Ken: Correct, it is possible to change your W-4 during the year. You’ll need to contact your payroll office. Checkout the W-4 assistanct at also has a W-4 assistant to help you determine the number of exemptions to claim, and what allowance you need to make for a mid-year change.

  21. As said up-thread, it’s probably best to choose the route that best fits your “fiscal temperment.” Me, I pay more and get the bigger refund, but, being in California, the IOUs have me thinking twice this year.

  22. Dan, keep on doing it b/c you self proclaimed you are weak.

    The refund amount you are getting back is not that huge anyway, so I wouldn’t sweat it.

    I’ve had refund amounts back as much as $30,000, which is a loss right now of about $600 in interest income… but not really, b/c it’s not like my first paycheck of the year will be up $30,000.

    I treat my refunds as a mini bonus, and not having it in the bank helps me save.

  23. I intentionally underpay so I don’t get a large refund each year. Actually, I’ve had to pay a little bit for the last 4 years. I’m okay with that because I would rather save my own money instead of giving the government a free loan.

    I do agree with the reader that if he lacks the discipline to save money each money, he should continue to do what he is doing.

  24. This is actually the same theme as most of the personal finance arguments on the web.

    Mathematically and financially, the path of deliberately delaying your tax refund money via excess withholdings is not the best option available. However, the claim is that the best option is not workable because you’ll rush out and spend the money once you have it.

    I hear this exact same scenario and argument over and over again. Purchasing something with a credit card and paying it off before interest charges occur is financially better than paying with cash or debit card, but many people advise NOT using a credit card because they will go crazy with it. Similarly, paying down the highest interest debt first is surely the best way mathematically to get out of debt, yet many advise paying off other debt first because they are afraid people will get discouraged. Lots of sub-par investments like (non-renting) vacation homes are also justified by the fact that at least the mortgage is a “forced savings plan” and better than just blowing the money that’s in your pocket.

    I’m pragmatic enough to see that if people really cannot control themselves with the best option available in these scenarios, then it’s really NOT the best option for them. However, people can also change and learn and grow. A lot of people sell themselves short their whole life by insisting over and over at every scenario that they “can’t handle” the most financially sound choice. That often adds up to a huge pile of money over one’s lifetime.

  25. I always get a fairly large refund and I even have 7 exemptions. When I do the worksheet it says I should have 15 exemptions on my W-4. I have read that anything past 10 is a huge flag for the IRS and that is the last thing I want to do. I guess I can just set it to 10 and be okay, but is that really the best thing?


  26. Dan:

    If you are overpaying taxes as a way to manage your money, you already know that this is not the “most effective way” to manage your money.

    Take it as a challenge to yourself to learn the self-discipline necessary to get and maintain control of your spending habits.

    If you can learn to manage this extra $500 then you can probably find ways to more effectively manage another $500 of your expenses each month.

    In a few years you will not only have your emergency fund covered and debt paid you will also be well on your way to financial independence!

  27. I had a very low HECS (higher education contribution scheme) debt and paid it off quickly, but still get the repayment taken out of my pay. I still save other income, but this creates a buffer for any extra tax I may have to pay on side-incomes, is a big psychological boost and gives me a lump sum to do something large with (now: maxing out my permissible early mortgage repayments). On a purely numbers basis it would be more sensible to put that into savings every week, but this *works* and works well.

  28. Getting a large tax refund is for mental patients. The “forced savings” aspect notwithstanding, it’s the financial equivalent of a fat person who padlocks the fridge. Or a smoker who tells her kids to “hide Mommy’s cigarettes somewhere good.”

    If you’re really that afraid you’re going to spend whatever leftover money you earn throughout the year on something stupid, set up either a 401(k) with automatic deductions or an account that buys you some conservative investment (Treasury inflation-protected securities, muni bonds, whatever.) Automate it, don’t think about it, reap the benefits every April 15. Understand the fundamental truth about the U.S. tax system, which is that it’s wired to take advantage of the very wage-earners who can’t exercise enough discipline to save money throughout the year.

  29. If I were like Dan and pretty certain that the extra money would just disappear every month and not go to pay down debt (which would be ideal but maybe not practical for him right now). I would get an online savings account like ING that was set to automatically withdraw whatever the overpayment was. That way you don’t have to think about it and it’s there. He could still use that money to pay off debt or for emergencies. I would worry that something would come up in December before tax refund time came around.