A big refund from the IRS could be costing you money

April 04, 1993|By Knight-Ridder News Service

Is it good to get an IRS refund check, or should workers pay just enough income tax to break even at year-end?

That question has been the topic of great debate between Robin Scott-Reese and Laimondo Trowell, a couple from Trevose, Pa.

Ms. Scott-Reese says IRS refunds are no bargain. It simply means you paid too much income tax during the year, she says, and that deprives you of money that could have been saved or invested.

Mr. Trowell, however, sees things differently. To him, an IRS refund is like a savings plan, except it pays no interest. By paying a little extra tax during the year, you get back a lump sum later.

Who's right?

Actually, they both raise valid points.

According to the IRS, refunds this year are averaging about $1,040. That means most refund recipients overpaid their income taxes by about $20 a week.

Suppose that money had been invested each month in a bank account. If the account paid 3 percent interest, compounded monthly, each person would have ended last year with about $1,057, including $17 in interest.

Clearly, you won't grow instantly rich by saving that money, but $17 in interest is better than nothing, which is what you get by letting the IRS keep your cash all year.

But to earn that $17, a person would have to invest that extra money religiously, and few people have that kind of discipline. Many would probably spend the cash and end the year with nothing.

Therefore, for people who lack the discipline to save, an IRS refund is not such a bad idea. If nothing else, it forces you to save, though it pays no interest.

Here are some better strategies, however.

Instead of simply saving that money in a bank account, you could have your employer add it to your 401(k) retirement plan.

With a 401(k), workers can have money deducted from their paychecks and invested in stocks, bonds or a combination. And like the IRS refund, a 401(k) can be a painless way to save. The money is deducted before you see it.

Another option: investing the money in a mutual fund. Generally, a mutual fund requires an initial deposit of at least $1,000. But some funds will accept much smaller amounts if investors agree to have deposits automatically deducted from a bank account each month.

Even if you opt for a tax refund each year, you still could invest that lump sum in a mutual fund. The idea is to start a long-term investment plan that can help secure your financial future.

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