Stop Using Your Tax Refund as a Savings Account

by Miranda Marquit · 20 comments

Over the holidays, my husband’s family spent quite a bit of time with us. His brother mentioned that he is expecting a nice, large tax return. “I use it as a sort of savings account,” he said. “That way, I know I’m getting something back.”

Before I could help myself, I blurted out: “But why? You’re giving a free loan to the government. That’s money that could be working for you!”

My brother in law’s remark isn’t really very rare, though. Many people view their tax returns as a sort of savings plan. They don’t claim all of their exemptions when they fill out their W-2 forms, or they have extra money withheld from their paychecks for taxes. That way, when the end of the year comes and it’s time to prepare the tax return, a tax refund is offered. In fact, the IRS reports that the average tax refund is more than $2,000. While that is a nice chunk of change, getting it back from the government isn’t exactly the most efficient way to build wealth.

Here are two reasons that you should stop using your tax refund as a savings account:

1. You aren’t earning any interest

Even with a traditional savings account, you are earning interest. It may be less than 1% annual yield, but it’s still a yield. Other savings vehicles, such as high yield savings accounts, CDs and even rewards checking accounts, offer better returns. When you have extra money withheld from your paycheck to work as a “savings plan”, you are really just providing an interest-free loan to the government. That’s not free money you’re getting — it’s your money being returned to you. But if you had lent it out using a person to person lending program, or if you had lent it to the government through bonds, you would have earned a return. Instead, you are inefficiently tying up money that could be going to work on your behalf.

2. You could spend the money on something else

It may seem strange to think of it, but you could be using the money you have sent to the government for things of more immediate benefit to you. If you get a $1,200 tax return (which is lower than the average), that’s $100 a month you could be using on something else, rather than tying it up for no good reason. Many people use their tax returns to pay down debt. They “save up” that money, and then pay down their debt with it. However, during the whole year that they are saving up to make a bigger payment, they are paying a high rate of interest — probably in excess of 15%. If you have debt, and use that $100 a month to pay down the principal, you will reduce the amount you pay in interest over the year. However, if you save up to make a bigger payment, that interest is not saved. You could also be using that extra money to pad your retirement account or boost your emergency savings. And, you would be earning interest on those true savings plans.

Bottom line

In the end, it is a good idea to try and get your tax return as close to $0 as possible, and put your money to good use. If you are really daring, you could even arrange it so you owe money. That means that the government has been giving an interest free loan to you! Just be careful; there is a penalty if you owe more than $1,000.

Editor’s Note: I personally have a slightly different view on this. I totally agree that having too much withheld and paying interest on your debt is not a good idea, but letting Uncle Sam keep your money instead of having it in a savings account could work well if it makes you feel more of a need to save throughout the year.

Additionally, I would consider how you react when you receive a big tax refund every year. Do you put every cent into savings, or do you always use some of it for something you really wanted? All these factors will affect what’s right for you. That’s why personal finance is personal, and that’s why it’s so interesting.

The key is to thoroughly think about the choices, and make an effort to decide (instead of making the default choice decide for you).


{ read the comments below or add one }

  • Daniel Estefano says:

    I suppose what ever works for you is what you should be doing; there is no one right answer for everyone. Years ago when I thought that I had paid all of taxes and had managed to save a bit of money for a vacation I was informed that I owed $4000 in taxes. Needless to say there went my vacation.

    Ever since then, as a self employed contractor even though I fund an annuity, I always overpay my taxes and get a huge refund. With that refund I fully fund my IRA for the year in April and after that I fund my annuity and put more money into my emergency/vacation account. Recently I read that one needs to put enough money away into a retirement account that it hurts. Even though it is my money, when I get it back I invest it. If I had a few extra dollars per cheque I spend a bit more so, as I said at the beginning of my post: whatever works for you.


  • Miranda says:

    Thanks for pointing that out. What I meant, of course, was the W-4. What a difference a number makes.

  • Ed Collins says:

    There is an error in the above article. The author wrote, “…They don’t claim all of their exemptions when they fill out their W-2 forms…”

    No one “fills out” a W-2 form. The W-2 form is the form you receive at the end of the year, from your employer, which indicates the money you’ve earned, the taxes you’ve paid, etc.

    The form the author is referring to, to claim the number of your exemptions, is the W-4 Form.

  • Larry says:

    I prefer a federal refund because I also always owe my high-tax state a few hundred. Besides, I can’t be certain of my deductions from year to year; sometimes I can itemize very favorably and other times I barely make it or have to take the standard.

  • Holly says:

    Our tax situation changes from year-to-year…I’d rather play it safe and wait for a refund than find out I owe.

    Also, I do my taxes as soon as possible, set it aside, and eventually apply it to my 3 children’s school tuition…the school gives a 5% discount if the tuition is paid in full by Aug. I make more money doing this than I could have in a cd or savings account.

    And…that’s why it’s called personal finance.

  • jerry says:

    I think that most people simply don’t have the self-discipline to save the money themselves, to they are happy to let the government take the lead and use it for a year, and then get it back later. It’s not ideal, and it offers no insurance for them to maximize their own money, but it’s kind of the default decision. Unfortunately.

  • Nick says:

    It’s really easy to rely on money that is coming to you later, but nobody can tell exactly when that money will arrive. If people found a different way to save money instead of waiting on a tax refund, the refund can be a better bonus for something else.

  • Kristoffer says:

    I work with many, many people that always get excited about how much money they are getting back at tax time. The way they talk about the refund makes it obvious that they really do think the government is “giving” them money as opposed to them getting back money that is theirs.

    Most of those people talk about going out and spending it on something they want – flat screen tv’s, computers, down payment on a new car, etc. And it drives me nuts.

    If the only way you are going to save is by giving the gov’t a free loan through the year, then fine. But if you don’t have the sense to figure out it’s YOUR money to begin with then you probably aren’t in a good financial place anyway and would piss it away no matter when you got it.

  • Miranda Marquit says:

    Thanks for all the comments. As David points out in the editor’s note, it really is a personal decision. I can see the mental argument for a large tax return, but it really doesn’t do it for me, since I know it’s not actually free money. I guess if I didn’t save any other way, I’d feel better about it. But I’d rather have the interest.

  • Craig says:

    A few people have mentioned this but I do it more from a mental aspect. The very little money that could be earned from interest is minimal to what it does for me mentally. I would rather have the hopefully decent size lump return check and feel great about it, almost like a bonus that I can use to increase my retirement fund or put toward a future vacation.

  • Calimechengr says:

    I just graduated college in may and started working in June. When I filled out my W-4, I made sure my withholding would be enough where I could get the most out of my paycheck without having to pay taxes and without receiving a large refund. However, I realized just this week I can claim a credit for the tuition I paid last spring. I will be receiving a large refund this year due to that credit, but all of it will go toward paying student loan debt.

  • Cd Phi says:

    I totally agree. I probably wouldn’t arrange to owe money as you said because that is a bit risky but I would definitely rather use that $100 a month to pay for my student loans that way less interest will accumulate. I do think it is natural for people to be so excited to get their tax refunds because it’s easy to forget where it came from, essentially from you and your working hours…

  • Phil says:

    I agree….in principle. While my wife and I use the money each year to fund our emergency fund, I would rather get a few thousand back and not owe the government ONE RED CENT. (I was burned in the past)

  • marci says:

    I agree with you. I’d rather owe uncle sam than get a refund – and I plan it so it is as close to $0 as possible.

    But why? you asked…. some people have NO self discipline – it’s the only way they can “Save”… that’s why they do it. If it’s the only way they can save, who are we to say no to them.

  • I’m one of those that feels that you should not be getting a huge refund each year. I would prefer to put my money to better use that letting the government use it for free. Unfortunately, most of the people that get those huge refunds use is frivously instead of actually saving the money. When I hear people say that when they get their tax refund, they are going to buy xyz, it makes me cringe.

  • Lulu says:

    I never understand the people who are happy to get gigantic refunds because I feel the same way you do. I actually had a coworker mention yesterday that she got $3000 back last year and thinks she will get more so she is going to use that money to buy a big screen tv and some new furniture.

    I think if she had withheld a little less and saved up she would have had the items earlier and earned some interest but that is the mindset that she has.

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