In Defense of Allowing a Larger Tax Refund

Well tax season is upon us,  and as I get ready to do my own taxes I'm reminded of the common advice I have heard throughout the years -  that you should strive to get a small refund back after you file taxes.   The argument goes like this - if your exemptions and withholdings aren't done properly you will end up with a large tax refund (or in a negative light - owing a lot of taxes) which essentially gives the government a free loan with your money and robs you of the interest you could be making on the extra money you see in your paycheck.   I can see the point in this argument and for some people that may make a lot of sense.  However, I don't believe that is wise advice for all people (and I include myself in that category).   Why is that? For the following reasons:

1. How many of us actually save the extra money we would have in our paycheck if we did our withholding numbers perfectly?   

For me, the temptation to use the money for other categories (not the saving one) in our budget would be too great.  If I was extremely disciplined in saving,  this could work out to my benefit,  but I believe more likely would be using it for other non-saving categories which would prohibit any windfall plans for the money after tax season.

2. How much interest do you really think you miss out on for giving an interest free loan to the IRS?

Depending on how much of a refund you are getting and the current interest rates of your investments,  I would guess it is $10 to $15 bucks over the course of the year tops.    Unless you are talking stocks / mutual funds with a tremendous return (which is always variable and more risky), the interest you gain by not getting a larger refund at the end of tax season may not be worth the chance that you would spend the money earlier.

3. The amount of value of this advice may also depend on what you tend to be more careful with - small amounts of money or larger (windfall) amounts of money.   

As mentioned in point #1 touches on,  if you could get $200 more a month back in each monthly paycheck or a $2400 refund at the end of the taxes, which do you think you would be more careful with?  Personally although financially there is no difference - I know for myself I would ponder more carefully what to do with $2400 given at one time then $200 a month more I see in my paycheck.  Now this may be a bad money practice,  but usually the larger the amount of money the more caution and consideration I give it.  A small amount of paycheck increase will probably just get used for other purposes,  but a larger refund gives me a chance to ponder how to best use the money.   Granted that may not be the best thought process,  but it how my mind works, and I think all savings/spending plans need to consider what is more effective for the individual.  

Summary:

So to summarize - maybe you can discipline yourself to save or budget correctly for the extra amount you make if you do your taxes perfectly and just owe the IRS $20 this year.  I personally find it more effective to give the government an interest free loan and then take the larger amount of money and carefully consider what to use the larger sum for.    Plus, as a bonus a larger refund gives me more motivation to do my taxes every year.  Getting $20 back seems like a small reward for the pain of preparing my taxes.   Just my two cents.