Here's Why a Huge Tax Refund Isn't a Good Thing

Before you celebrate that pile of cash, think about what it really means.

If you're getting a tax refund this year, you're no doubt in good company. Each year, millions of tax filers wind up with a pile of cash back from the IRS once they submit their returns. But while you might celebrate the idea of a large refund hitting your bank account, in reality, it's not a good thing at all.

A tax refund is not free money

There's a big misconception that tax refunds are free money. They're not. Rather, when you get a tax refund, it means you paid the IRS more tax than necessary the year before, and now you're basically just getting reimbursed.

What makes matters worse is that if you overpay the IRS a lot one year and get a huge refund, you're not entitled to interest on that money. Or, to put it another way, if you get a $3,000 tax refund this year, it means that last year, you gave the government a $3,000 interest-free loan.

But that's not the only problem with getting a large refund. By not collecting more of your money as you earned it, you may have put yourself in a position where you were forced to rack up costly debt.

Say at one point last year, you were $500 shy when a large bill arose, so you charged that bill on a credit card and have been paying it off ever since while accruing interest. Had you not paid so much extra tax, you might've gotten enough money in your paychecks to come up with that extra $500 when you needed it.

That's why you really shouldn't get too excited about a large tax refund. What you should do, in fact, is make changes to your tax withholding so your paychecks start increasing going forward.

How to have less tax taken out of your paycheck

If you're a salaried worker, your employer will use the information you put on your W-4 form to determine how much tax to withhold from your earnings. But you can adjust that information to have more or less tax withheld.

Say you're getting a $3,000 refund this year. If that's the case, and your income is similar this year to what it was in 2021, then you should probably fill out a new W-4 and claim more allowances. The more you claim, the less tax will be withheld from your earnings. This doesn't mean your paychecks will automatically increase by $250 a month -- but they should go up to some degree.

Don't miss out on money that's yours

These days, a lot of people are struggling with higher living costs due to inflation. If you typically get a large tax refund and your income situation hasn't changed much from previous tax years, it could pay to collect more of your earnings upfront this year instead of forcing yourself to wait. Doing so could buy you more financial breathing room -- and make it so you're not loaning the government too much money for nothing in return.