If you end up receiving a big refund from the Internal Revenue Service after filing your taxes, then you just gave the government an interest-free loan, which is exactly why most financial experts warn people away from withholding too much income throughout the year. But here’s the good news about getting a refund: You get to spend it. Or save it. Or do whatever you want with it. And chances are, if you received that money throughout the year in little dribbles on your paycheck, then you probably would have spent it by now.
Most Americans, in fact, overpay Uncle Sam through the year. According to the IRS, 2014 refunds are already ahead of last year’s refunds. Out of the 57.4 million returns processed as of early March, 48.4 million refunds have been issued, and the average refund was just over $3,000. That means the vast majority of taxpayers get a refund, and it’s a big one.
Here are some reasons why you shouldn’t feel badly about getting that money in one lump sum:
1. You can make a conscious decision about what to do with those funds.
Unlike slightly higher paychecks throughout the year, a big refund check gives you the opportunity for some reflection. How do you want to spend that money? Is it a good time to pay off some debt or make some progress toward a big saving goal? Or perhaps you can finally take a vacation or certification course you’ve been dreaming of.
When the National Endowment for Financial Education surveyed over 2,400 taxpayers in 2011 about their refund plans, about half said they would pay down debt and 44 percent said they would save the money. About one-third said they purposely withhold more money than necessary throughout the year so they can score that refund.
Refunds can also be put toward building a safety net. If you don’t yet have an emergency fund that could cover your immediate expenses should your income suddenly stop, then your refund can provide the seed money for it. Financial advisors typically recommend that you keep three to six months worth of expenses in the bank. NEFE urges anyone receiving a refund to first consider paying down debt, saving, paying for repairs, prepaying bills and lastly, splurging. NEFE’s site smartaboutmoney.org offers more advice.
2. You can use the refund to boost your happiness level.
At least one financial expert, John Strelecky, author of "The Big Five for Life," urges taxpayers to use their refund as mad money. He says after you consider the current average returns and inflation rates, people are better off using their refund money to enjoy life today, instead of saving it for some vague future purpose. “The point of earning money is to create memories, have amazing experiences and do interesting things,” he says. “Don’t wait until age 65 to start spending your money to live a rewarding life.”
[See: 9 Ways to Stretch Your Paycheck.]
He makes a good point. As you weigh potential splurges, recent research suggests that spending on experiences, like a family vacation, could bring more happiness than material purchases, like a new washing machine.
In 2010, by comparing consumption data from the National Health and Retirement Study, Thomas DeLeire, a professor at the University of Wisconsin-Madison, and Ariel Kalil, a professor at the University of Chicago, found that spending money on leisure activities, which include vacations, movie theater tickets and hobbies, improve happiness levels. (Happiness was measured by asking respondents to describe how they felt about their lives.) Expenditures on durable goods such as refrigerators, clothes, personal items and housing, on the other hand, did not have an effect on happiness.
The apparent reason behind the leisure spendinghappiness connection is even more intriguing than the finding itself: Spending on leisure activities appears to boost one’s level of social connectedness. That makes sense, since when you go on vacation, engage in a hobby such as tennis or bridge, or go out to the movies, you are almost always doing it with somebody else. So spending on leisure might boost your social connectedness, which in turn improves your happiness level.
[See: 9 Little-Known Ways to Pay Fewer Taxes.]
3. You can always adjust your approach for next year.
If you want to take a different approach for the current tax year, then you can adjust your withholding on your current W-4 form on file with your employer. (The IRS also offers a useful calculator to help: irs.gov/Individuals/IRS-Withholding-Calculator.) If you’ve undergone a major life change, such as getting married or having a baby, then you might need to make some adjustments on the form to avoid withholding too much or too little.
By withholding approximately the correct amount that you owe the government, you’ll avoid any major surprises next spring.