Recently, a tax refund check arrived in the mail in the amount of $1.
The check (pictured) was for my local earned-income tax refund for 2013.
To many, that type of tax accounting is perfect – to have just the right amount of taxes deducted throughout the year so that when next April arrives, you don't need to pay anything. And, at the same time, you won't have the government temporarily holding any significant amount of money of yours during the year.
That is my philosophy with respect to local earned-income tax and Pennsylvania's income tax.
But it is not my approach when it comes to the federal income tax.
I believe in forced savings – having extra amounts deducted from my paycheck throughout the year in order to ensure a hefty federal income tax refund the following spring.
Yes, I recognize that I am losing access to the money and not earning any interest on the money.
But if you can afford the extra deduction, this is a great way to save money. Because I do not have the discipline to throw X amount of money in a separate account every payday – and then not touch that money all year.
Besides, if you do the math, you are not losing much money at all by letting Uncle Sam hold your money all calendar year.
Assume you get paid every other week and that you are deducting an extra $100 from your paycheck for taxes. All things being equal, that would correspond to a tidy $2,600 federal income tax refund the following year.
In terms of interest lost on that big deduction, assume an average balance of $1,300 on a savings account that pays, these days, about 1 percent. If you had the discipline to put away $100 every payday, you would only net an additional $13 for the year.
That $13 is a small price to pay to ensure that you will, in fact, have a nice extra payday every April.
Even if you only deducted an additional $50 every paycheck, that still translates into a $1,300 refund the next year.
The caveat with this strategy is that you also should be socking away money in a 401K or other retirement plan. That should be the top priority.
But if you can do both, even better.