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Tax refunds could be significantly higher next year

The Motley Fool logo The Motley Fool 6/21/2018 Maurie Backman

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Each year, the majority of folks who submit tax returns wind up getting a refund. And in 2019, those refunds could be higher than in years past -- 26% higher, in fact, according to projections from Morgan Stanley.

Why the anticipated boost? We can likely thank the recent round of tax changes that went into effect for 2018. A big part of that overhaul included lowering virtually all individual tax brackets so that workers get to keep more of their income. But an estimated 75% of workers who were already having too much tax withheld in previous years may not adjust their withholdings appropriately given those tax changes. The result? They'll have even more tax withheld than necessary, thereby landing in a situation where their refunds go up.

However, while the idea of getting a larger tax refund might sound appealing, the reality is that it's actually a problem. And the sooner more workers realize that, the better positioned they'll be to prevent it.

It's not free money

One major misconception about tax refunds is that those lump sums constitute free money. In actuality, when you get a refund, you're not getting free money, but rather, your money that wasn't given you to when you earned it.

Now if more of us were financially stable and had the savings on hand to tackle unplanned bills, that lag in getting our money wouldn't be so bad. However, most Americans are behind on emergency savings, which means they're often forced to pull out their credit cards when unexpected expenses hit them. And these are the same people who should not be getting tax refunds, but rather, should be collecting more of their earnings as they go. And the fact that refunds are projected to be even higher next year means Americans will wind up forgoing even more essential cash up front, when they need it.

Here's a basic example to further drive home the danger of tax refunds. Imagine you're among the 75% of Americans who live paycheck to paycheck with virtually no money in the bank. You encounter an unplanned $200 bill you can't cover, and then proceed to rack up $40 in interest on that sum over the course of a year when you fail to pay it off right away. You also get a $2,400 tax refund, on average, each year. Now imagine that instead of having that extra $200 withheld every month, you collect it up front. Getting that money would've prevented you from charging that $200 bill and throwing $40 away on interest in the process.

Remember, when you withhold too much from your paychecks, you give the government an interest-free loan for nothing in return. So rather than do that, see about adjusting your withholding so that your paychecks get larger month after month, and your refund shrinks in turn.

If you're worried about underpaying your taxes throughout the year, take the extra money you get in each paycheck and stick it into a savings account. If, come tax time, you see that you owe the IRS money, you dip into that account and pay your tax bill. And if you don't owe money, that cash is yours to keep, and so is the interest you've been earning on it. At the same time, that account can serve as an emergency fund of sorts so if you happen to come across, say, a $200 bill you can't pay, you can withdraw that sum from your savings rather than rack up needless interest charges. It's a far better bet than losing access to that money and struggling as a result.

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