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According to the most recent data, the average tax refund is $3,207 per taxpayer as of Feb. 16, which is 2% more than the average refund at the same point in 2023.
Millions of Americans look forward to getting their tax refunds every year, and with an average amount like this, it’s no surprise. After all, a sudden infusion of a few thousand dollars can help you pay off credit card debt, build your savings, invest, or pay for a large expense.
However, if you are receiving thousands of dollars back from the IRS every year, it isn’t necessarily a good thing. Here’s the problem with a large tax refund, and what you might want to do about it instead.
An interest-free loan
Take a moment and think about why you get a tax refund. Throughout the year, your employer withholds money for your federal (and state, if applicable) income taxes and sends it to the government. These withholdings are based on information you provided when you got hired, such as your number of dependents and your marital status. And if you’re self-employed, you likely make quarterly estimated tax payments to the IRS, based on your expected tax liability.
Then, when tax time rolls around early the following year, you or your tax preparer complete your income tax return, which calculates the amount of tax you owe for the year. If the amount you’ve paid through withholdings and estimated tax payments exceeds the amount you owe on your return, you’re entitled to a tax refund.
In other words, you give the government your money throughout the year, and if you overpay, you get the difference back. For example, if your withholdings total $20,000 for the year, and your tax is calculated to be $15,000, you get $5,000 back.
By doing this, you are effectively loaning the government money and receiving no interest. You are giving the United States Treasury an interest-free loan of your money.
What you can do instead
If you’re getting a modest tax refund each year — say, $1,000 or less — it’s probably a good idea to leave it alone. After all, it’s more desirable to slightly overpay than to find out you owe money at tax time.
On the other hand, if you are receiving the average tax refund of about $3,200 or even more back, it could be time to rethink your withholding. Think of it like this — would you rather have a $3,200 tax refund, or another $123 on each of your bi-weekly paychecks?
If you’re saying that you’d rather have the $3,200 all at once, consider this. By making your paychecks larger, you could put the extra money into a high-yield savings account each time you get paid and you would end up with more than $3,200 at the end of the year.
A too-large tax refund is a good problem to have, but it’s still a problem. Fortunately, it’s an easy fix. By visiting your payroll department, you can instruct them to withhold less money from each of your paychecks, so you ensure you get all the pay you deserve throughout the year.
If you picked up a side hustle that paid you an extra $100 or $150 every couple of weeks, would you be willing to wait until next April to get paid? Of course not. So why would you want to wait to get the portion of your earned income that a tax refund represents?
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