Are Tax Refunds Hindering Employee Financial Goals?

Every spring, Americans reconcile their taxes, determining how much they actually owed to the IRS and how much they paid throughout the year. Typically, Americans paid more taxes than they actually owed. In fact, the IRS sent refunds to 83% of taxpayers in 2015, averaging $2,700. A large part of the reason for these refunds is that workers do not update their withholding information and they end up giving a lot more to Uncle Sam than they should.


Why is over-withholding a problem?

Consider a worker that starts when he is single and fills out his W-4 properly, so his withholdings pretty much match his tax burden. Over time he gets married to a lower-earning spouse, has children, and buys a home. All of these things reduce his tax burden, but his withholdings are still based on his old W-4 information. So the IRS ends up holding a sizable portion of every paycheck and giving him a large lump sum every spring.

Although this worker—and probably all Americans—may enjoy the moment when a refund shows up, does lending money to the IRS (at no interest) throughout the year and collecting it every spring hinder workers from achieving their financial goals?

We examined HelloWallet users’ transactions and found some trends in refund spending, suggesting many workers do not use their tax refunds wisely at all:

  • Only 37 percent of workers saved their refunds, while the rest spent their refunds on mix of durable or nondurable goods.
  • The larger the refund, the more of it workers spent.
  • About one quarter of workers allocated a large share of their tax refunds to paying down credit card debt.


How can HR professionals help their workforce?

Many workers treat tax refunds as an unexpected windfall to be spent rather than saved or invested. Our previous research explores why employers are an important source of guidance for employees in situations like these. This may present an excellent opportunity for HR professionals to help workers to bolster their retirement savings. If workers were guided to raise their retirement contributions and offset this increase by reducing their withholdings to better reflect their taxes owed, it would be a pain-free way to direct more assets to retirement.

Of course, guidance would need to include careful messaging so that workers understood they could no longer count on big refunds. This is particularly true for workers that use their refunds to compensate for over-spending and building up credit card debt. Furthermore, some workers deliberately over-withhold their taxes to help them save for big-ticket items, and might not want to change. Indeed, the over-withholding strategy may be a good choice for workers that do not have the self-control to avoid spending money once it is in their bank accounts.

Nonetheless, the current payroll withholding system is not ideal for many workers. Workers would benefit from a change in their withholding, spending, and retirement contribution strategy—if such a change could be implemented holistically.


Aron Szapiro is director of policy research for Morningstar. Szapiro is responsible for developing research reports on policy matters, coordinating official responses to regulatory proposals, and providing investor-focused comments on policy issues to clients and the press. He also chairs Morningstar’s Public Policy Council. 

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