Budgeting

You're doing it wrong: How not to handle your tax refund

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A third of us will get a tax refund and spend it on necessities.

Young man buying produce in grocery store | Maskot/Getty Images

But that’s not the right move.

We should all, right now, adjust our withholding so that next year we’re not getting refunds. Go ahead, we’ll wait.

Having too much income tax withheld from paychecks will produce a larger refund, but it means we’re surrendering our money all year in a 12-month interest-free loan to the federal government.

And what’s worse: When we are getting our refunds, we’re using the money to buy basics like groceries and toothpaste. Let that sink in: We have been giving the government our hard-earned cash all year to get it back interest-free — the exact same amount we gave them — for basics.

How do we know this?

The newest Bankrate Money Pulse survey found 29 percent of people, a record-high for the fourth year of the survey, will use tax refunds on necessities.

Not cool.

Why choose a smaller tax refund | Bankrate

Greg McBride, Bankrate’s chief financial analyst, agrees:

“Adjust your paycheck withholding so that extra money lands in your hands every payday instead of Uncle Sam’s,” he says. “But the next step is even more important – use that extra money to increase your 401(k) contribution or have this direct deposited into your IRA.”

Excellent point. Instead of giving that extra money to Uncle Sam all year, let’s agree to put it in an account that earns interest.

“Instead of spending that $50 per biweekly pay period on morning lattes and having nothing to show for it, directing it into your retirement account makes your nest egg $7,600 bigger 30 years from now – and that’s the impact of just one year’s additional contributions. Keep that habit for the next 30 years, and with a 6 percent return, you’re looking at an extra $109,000 in your retirement account,” says McBride.

Want to see how much you’ll earn?  This calculator can show you.

Bottom line: Adjust your withholding. Earn interest. Buy as much toothpaste as you want.

Methodology: Bankrate’s poll was conducted by Princeton Survey Research Associates International, which obtained the data via telephone interviews with a nationally representative sample of 1,001 adults living in the continental United States. Telephone interviews were conducted by landline (500) and cellphone (501, including 298 without a landline phone) in English and Spanish from Feb. 16-19, 2017. Statistical results are weighted to correct known demographic discrepancies. The margin of sampling error is plus or minus 3.8 percentage points.

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