When tax season rolls around, I sometimes think back to the worst personal finance advice I ever got, back when I was in my 20s and my money was in a mess.
Because my finances were such a wreck, I’d bought a personal finance book (I can’t remember which one), which is where I got this tip: If you’re getting a tax refund, go straight to the human resources department at work to reduce the amount withheld for the IRS from your paycheck. After all, why let Uncle Sam hold your money all year when it could be earning interest for you?
I loved the idea of having more money in my wallet, so I immediately lowered my withholding amount (though I don’t think I followed any of the other advice in the book). I was very proud of myself for making such a good financial move.
At tax time, though, I got a nasty surprise. I owed around $700, a huge amount for me, and I didn’t have the money. Instead of putting my extra money in savings to accrue interest, I’d spent it on café mochas, dinners out and other random stuff.
The suggestion I’d gotten from the book, while fine advice for some, was a disaster for me — a young newspaper reporter with no monthly budget in place who was often late paying bills and regularly bouncing checks.
As Luke Landes at Consumerism Commentary points out, having too much withheld for the IRS can act as sort of a “forced savings,” which can be a good thing for consumers in shaky financial situations.
However, Landes also points out that overpaying on taxes isn’t the best way to compel yourself to save: After all, you don’t earn any interest that way. And Mint.com outlines the pros and cons of withholding for taxes.
For me, the “forced savings” method had worked well: My tax refund helped put me in better shape every spring, giving me a lump sum that allowed me to pay big expenses or pay off any credit card debt I’d accrued.
So, if you’re one of the 80 percent of Americans who gets a tax refund, what should you do? If you budget well, save regularly and have an emergency fund, you might reduce the amount withheld from your paycheck, according to ClearPoint Credit Counseling.
However, if you’re not great at managing your money, then getting a tax refund can give you a financial boost, according to ClearPoint. Instead of spending your refund on a vacation or shopping spree, consider using it to create an emergency fund or to sock away for retirement, ClearPoint recommends.
If you still need help deciding how much to have taken out of your check, the IRS offers a withholding calculator.
After I ended up in hock to the IRS years ago, I panicked and ignored the problem for a while. Finally, I called and set up a payment plan. I ended up owing interest and penalties that increased the size of my total bill to about $1,000, and it took me over a year to repay my debt.
I also got a valuable lesson: Personal finance advice isn’t one-size-fits-all. It’s important to know yourself and weigh personal finance advice against your strengths, weaknesses and habits. Remember this: The strategy that works for a millionaire personal finance guru might not be right for you.