Most, Least Effective Tax Withholding Strategies

Advisors might tell taxpayers that they should minimize their tax withholding and put their money to work throughout the year, but that’s not what the people are interested in doing.

A new MoneyRates.com survey of more than 1,100 workers found that Americans really love their tax refunds. Most prefer to receive a refund rather than receive larger paychecks throughout the year.

MoneyRates.com’s senior financial analyst, Richard Barrington, noted that experts recommend managing withholding so it equals the likely tax bill: workers get more take-home pay and don’t owe the government any money. But more than two-thirds (68%) prefer the refund.

Less than a third of those who prefer refunds spend most of the money, while nearly half of those who would rather minimize withholding spend their extra money, according to the survey results.

“This suggests that people find it easier to save money when it comes to them in large chunks,” Barrington wrote on MoneyRates.com. “When it arrives in small incremental pieces, it is too easy to just fritter the extra few dollars away.”

He added that putting money to work as soon as possible isn’t very important with interest rates near zero.

Although there are a lot of individual factors to consider when choosing a withholding strategy, Barrington ranked where withholding and spending strategies would fall in a perfect world.

Hierarchy of strategies

(Least to most effective)

4. Spend the refund

You can wait to accumulate money through a refund during tax time and simply spend the windfall. This, according to Barrington, is the worst since you’ll be waiting longer to get the money and once you get it, the money isn’t used for anything constructive.

3. Take home more and spend it

Minimizing your withholding tax and simply spending the extra money you go home with doesn’t really help in the long run. And yet nearly half of the people who minimize withholding do this.

2. Save the refund

Once you receive that tax refund, put it away and save it. Roughly 70% of people receiving refunds are saving at least half of it, so this seems to be a pretty popular strategy. However, Barrington points out that if rates on savings accounts perk up, you could be losing money by waiting until the end of the tax year to deposit the money.

1. Minimize and save

The extra money that you take home should be automatically deposited into a retirement plan or savings account to remove the temptation of spending it as soon as you get your hands on it. Plus, you’ll be putting your money to work for you as soon as possible.