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Americans Plan to Use Their Tax Refunds Wisely -- but Should They Be Getting Refunds at All?

Maurie Backman, The Motley Fool

Though refunds were slow to come in this year, a good 65% of taxpayers expect some money back from the IRS this season, according to a new survey from the National Retail Federation. And thankfully, they're planning to put that money to pretty good use. Specifically, 84% of refund recipients plan to use that cash to pay down debt or pad their savings .

That said, the fact that so many households rely on tax refunds to improve their financial picture is problematic on several levels. And the sooner more taxpayers realize that, the sooner they can make changes to grow less dependent on money that may or may not come in.

Hundred-dollar bills falling from the sky

IMAGE SOURCE: GETTY IMAGES.

The problem with tax refunds

Many folks are quick to liken tax refunds to sudden windfalls, but that's far from the truth. When you get a tax refund, that money is coming in because you didn't get to collect it up front in your paychecks. The IRS isn't giving you a gift; it's returning money to you that you should've gotten your hands on sooner. As such, you shouldn't depend on a lump sum in April to boost your savings or get out of debt; you should aim to collect that money as you earn it so that you're not forced to rack up debt, or fall short on your savings goals month after month.

Here's the other thing about tax refunds: They're not guaranteed. And many Americans are learning that the hard way this year in particular.

In 2018, the tax code underwent a major overhaul that resulted in a lowering of virtually all individual tax brackets. The purpose of that move was to put more money into workers' pockets during the year. To accompany that change, the IRS released new withholding tables for employers to follow. Those tables dictated how much tax employers were to hold back based on the number of allowances claimed therein.

For the most part, workers saw their take-home pay go up during the year, even among folks who didn't change their withholding or get raises. The problem, however, is that many folks failed to realize that those higher paychecks would, in fact, take the place of a refund (or a more substantial one) at tax time. As such, a large number of filers who were counting on money back this year are instead scrambling to pay the IRS money instead. And while that's actually a preferable scenario to getting a refund (since it means you got more money up front), it's problematic for those who aren't in a position to get their tax debt paid off by the April 15 deadline.

Get your withholding right

Though it's encouraging to see that Americans are aiming to use their refunds responsibly this year, the fact of the matter is that if you're working, you're better off getting more of your money up front, and less back from the IRS. Therefore, if you're anticipating a sizable refund this year despite the aforementioned tax changes, you may want to adjust your withholding to claim more allowances. Having that extra money in your paychecks might help you avoid debt when you're hit with unplanned expenses. Similarly, it might help you increase your savings so that you're equipped to tackle unexpected bills.

If you aren't getting a refund this year but don't owe the IRS much, you should probably leave your withholding as-is. And if you underpaid your taxes substantially, you should claim fewer allowances to avoid a repeat scenario.

But don't give up on your savings just because you don't see a refund coming your way this year, and don't expect one the following year, either. Instead, set money aside from each paycheck to go into the bank. Better yet, automate the process so that cash gets transferred automatically, before you have a chance to spend it. At the same time, revisit your budget if you feel you're at risk of debt. Having more money in your paychecks can help you avoid that fate, but only if you manage that money responsibly.

Though tax refunds are commonly regarded as a positive thing, they're actually not -- even when used responsibly. If you have a big one coming your way this year, take steps to get more of your hard-earned cash as you go along. It'll give you more flexibility and help you avoid so many of the financial hiccups countless Americans face.

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