Can I borrow $2,500 and give it back to you next April?
You: Are you going to pay me interest?
Now that you mention it–nope. No interest. Just the $2,500.
You: No way. You’ve got to pay me interest. That’s my money you’re talking about. I’m no charity.
Good to hear, right answer. Yet unfortunately many people just like you make a similar interest-free loans to the government every year by receiving big income tax refunds. Furthermore, many people rationalize their sizable refunds by calling them savings.
You: Yeah, that way even if I don’t do any savings all yearlong, I know I have a couple of grand coming to me next April.
What did you use the money for when you got your refund last year?
You: Well I debated between this high-def TV and a really nice vacation – but then wound up using most of it for tickets to–
You didn’t really save it then, did you?
You: No, not really. But I had a great time!
And that’s my point. It becomes a slush pile for you to spend on something you’ve had your eyes on. Yet my hope is that you never get that refund again.
You: Excuse me? That sounds almost Gary-like. You trying to separate me from my money?
Of course not, but that income tax refund is usually just bad financial planning. I want you earning interest on your money as you earn it, not the government.
You: Come again?
By re-filing a Form W-4, you can give yourself a raise.
You: You sure?
Absolutely. If you keep getting a large federal income tax refund and expect that to continue next year, simply lower your federal income tax withholdings using Form W-4 and you’ll enjoy an increase in your net pay right away.
For help adjusting your withholdings, see the IRS’s calculator but going to the IRS web site and typing in the search box “withholding calculator.”
Even those more responsible types who use the refund money to pay back some existing debt are making a bad financial decision. By following the steps outlined above, they could be paying off more of their debts sooner, saving significantly in the amount of interest they pay!
“personal finance” 
“financial education”
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Hi – I heard part of your program on Seacoast Sunday (wish I caught the entire broadcast). If I’m one of the first 5, I would love to have a copy of your book. Thanks – Jackie
Jackie, I plan on posting the entire program to my web site (with a link to it from this blog) shortly so you may get your chance to hear the entire broadcast yet! In fact, you were one of the very first to respond this morning, so you will receive a free book! Welcome aboard – and I look forward to our conversation!
Hi- I attended your seminar in NYC at ING direct about a month ago and I recall you mentioning this ’strategy’. I had a question but did not get to ask at the time. I am interested in lowering my tax withholdings but I have heard that at the end of the year you may end up OWING money to the government. How can I ensure that I can in fact lower my tax withholdings without owing the government any money? I can be kind of naive when it comes to these things and dont want to make a mistake that I may have to pay for. Thanks!!
Wesley-
Good to “see” you again. This is an excellent question.
The best way to ensure you don’t owe the government money is to use a calculator to estimate the right number of allowances to claim on Form W-4 (which determines how much is withheld from your paycheck.) There is a calculator at the IRS website (search for “Withholding Calculator” from http://www.irs.gov Total Candor also has a calculator, available here: http://www.totalcandor.com/calculators/401k.php
From a financial planning perspective, owing money to the IRS is actually a good thing. Doing so means you held on to your money as long as possible, earning interest on your savings the whole time. Of course, this statement assumes two things. First, that you actually save the additional net pay you collect so you have enough to pay the IRS next April. The second assumption is that you will still withhold at least 90% of your total tax. So, while you can owe up to $1,000 if your total federal income tax for the year is $10,000, you can’t owe $5,000. If so, you’ll be subject to a penalty (not good).
Be careful, but don’t become overly cautious. If you are routinely getting large federal income tax refunds, make a change to your withholding. You don’t have to go all the way to the point you owe, but at a minimum, lower the amount owed to you. Start collecting now.
(Be sure to look at the calculator again in January to reflect the full year.)