The answer is – it depends. While receiving a large refund feels great, it is important to acknowledge that a large refund is an inefficient use of capital. You are giving the Federal Government an interest free loan for at least 12 months. In 2018, this 0% interest loan from the American people is expected to be about $350 billion.*
However, what really matters is how the refund impacts your peace of mind. Some people think of it as a 0% interest free savings account that will help to cover an emergency expense in 2019 or fund a vacation or a major home purchase. Also, the federal refund often arrives in a timely manner to help pay tuition for private schools. In this regard, it makes planning for major expenses easier.
Yet, that presumption is risky, especially when major changes occur in life or if you become a victim of identity theft. By no fault of your own, you may be unable to access your refund because you were the victim of identity theft. If on purpose or by accident, a person somewhere in the world files a US Tax form that references your social security number, you will be blocked from collecting your tax refund for an additional 11 months as the IRS investigates the issue and corrects the records. Worse, if you file “Married Filing Separate” as a tax saving strategy, you may find yourself in a real mess where you are unable to collect the refund owed to you, while still being liable for the tax payment owed by your spouse.
I think it is always better to keep as much cash as possible under your own control to achieve your own vacation, emergency or investment goals. If you agree with me, you want to withhold only enough money to pay the federal taxes due. In a worst-case scenario, you may end up owing the government money. That said, as long as you can afford to pay what you owe, you are enjoying a 0% interest loan during that full year on the amount owed. It is important to always remember, that if you owe money, you must file your taxes by April 15 and must pay interest and penalties on any debt owed to the Federal Government after April 15.
If, over the course of the year, you become concerned that you are not withholding enough, you can always send an estimated tax payment to the IRS. The IRS is always happy to accept estimated tax payments.
So, is getting a large refund a mistake? The answer is it depends on the needs and concerns of the individual tax payer. No matter what your decision is, the goal is to not be un-pleasantly surprised during your tax meeting. Consider working with CFP® professional to help determine what’s right for you.
*UBS expected a $42 billion increase in refunds due to 2018 tax law changes. Motley Fool research indicates that $302 billion was refunded in 2016.