Are You Giving the Government an Interest-Free Loan?

Some people actually look forward to tax time because they expect to get a refund. They prepare their return and then eagerly await their "windfall" of several hundred (or even thousands) of dollars. 

If you're one of these people, consider this: A refund means you overpaid the IRS last year – you gave the government more money than you actually owed in taxes.

According to recent statistics from the IRS, the average income tax refund was about $3,050. Data from the Census Bureau shows the median income per household is approximately $61,372. After paying 30 percent in federal, state and payroll taxes, the average household nets around $42,900 — meaning people in the median American household are lending the IRS almost 7 percent of their annual income during the year for no good reason.

Remember that a refund from the IRS is not a gift from the government; it's merely the return of your own money to you. If you get a refund, it means you gave the IRS an interest-free loan in the prior year. Would you lend Macy's $3,050 and be excited when you got it back the following April with no interest? Of course not! Yet that's exactly what happens when you overpay your taxes: The IRS returns only the amount you overpaid, with no interest, regardless of how much money you "loaned" it.

If you get large refunds each year, you're probably claiming too few exemptions on your IRS Form W-4 or, if you file quarterly estimated tax payments, you're paying too much. Talk to a tax advisor to make sure you're claiming all the exemptions you can or, if filing quarterly estimates, you're sending payments that are close to the amounts you actually owe. Then take the money that you no longer are sending to the IRS and invest it instead.

This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.

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