Each year, about two in three taxpayers receive a refund from the IRS. Last year, nearly 105 million people got an average of $3,138 back, and that’s fairly typical for recent years.

Tax refunds are a real chunk of change that can feel like an exciting windfall of “free” money. Some may feel relieved they can pay off their credit card balance. Or pumped to put it straight into the stash they’ve been building for a down payment on a house. Others may be looking forward to treating themselves (hello, new mocha mousse sofa!)

But within the big picture of saving and investing, does getting a refund make the most financial sense? Technically, a refund means you’ve made an interest-free loan to the government. Should you be a creditor to Uncle Sam when you could be using more of your paycheck to pay down debt or build up your 401(k)? Here’s what you need to consider.

Why You Get a Refund

The federal government taxes our income to help pay for the things it provides us — like national defense, roads and bridges, and safety net programs. If you’re an employee of a company or organization, you’re taxed throughout the year, with part of each paycheck going directly to the IRS.

How much is diverted is determined by how you fill out the IRS’s W-4 withholding form, which asks about your tax filing status, children, spouse, and income from side gigs or investments, as well as what sort of tax credits or deductions you may have.

In theory, the goal is to withhold just the right amount of money, so that you don’t owe the IRS any more and the IRS doesn’t need to return any to you.

But taxes are complicated, and the equation changes if you don’t keep your W-4 up-to-date, you don’t fill it out correctly, or you just don’t want to break even. Gear things too low, and you could wind up with a nasty tax bill. Set yourself up to pay too much, and you get a refund.

(Self-employed people don’t fill out a W-4 or have taxes withheld, but the same concept applies. They have to make quarterly tax payments based on their estimates of earnings, and they get a refund or bill depending on how accurate those payments are.)

The Benefits of Getting a Tax Refund

It might seem ironic that even though the IRS is Americans’ least favorite government agency, the majority of people are effectively lending it money at no interest. But taxes may be as much a psychological issue as a financial one.

If saving money is a monthly struggle for you, it may be worth it to overwithhold and let the government safeguard your cash in a lump sum. Best to have the IRS hold onto your dollars if you might otherwise splurge on something frivolous.

Or, if you’ve underpaid in the past, and had a burdensome tax bill (and maybe even penalties) take you by surprise, you may be overwithholding out of fear of owing money. That’s understandable too.

The Downsides of Getting a Tax Refund

But here’s why a tax refund doesn’t always make sense. Let’s say you got the typical refund of $3,138 last year. That effectively means your paychecks were $261 a month lower than they needed to be. So let’s explore what could have happened if you’d had access to that money a year earlier.

Maybe you had $5,000 in credit card debt accruing finance charges at a 15% annual interest rate. If you paid $361 a month instead of $100 a month, your balance after a year would have fallen to $1,161 instead of $4,517 and you would have saved yourself about $225 in interest.

Or you could have added the $261 to your monthly 401(k) contribution, giving it an extra year to grow. (If that money earned a 7% annual return — the average return for the S&P 500 Index historically — you’d still end the year with the $3,138 saved, plus about $100 in earnings.)

The other thing to consider is how disciplined you are once you get your refund. Are you apt to put it to good use?

A Lincoln Financial survey taken in November 2023 found that 40% of respondents expecting a tax refund planned to put it into a savings account for emergency expenses and 37% planned to pay down debt. These two choices were by far the most common, followed by buying something for themselves at just 16%.

But some academic research has shown households tend to increase their spending when they receive expected refunds.

And a survey last March by Intuit Credit Karma showed that about a quarter of taxpayers considered their tax refund “free money” that they planned to use for things they wouldn’t otherwise buy. Younger generations (39% of Gen Z and 36% of millennials) were the most likely to blow their refunds, and on things like clothing, electronics and shoes, the survey found.

Whatever You Do, Make It Count

If you get your tax withholding right on the nose, you can make more of your money work for you sooner.

But if you prefer to get a tax refund — for whatever the reason — make it count. Whether you pay down debt, give yourself more financial cushion, or build up your retirement savings, use the money to move forward with a financial goal.

And don’t forget to update your W-4 when your circumstances change. The IRS’s Tax Withholding Estimator shows you how changes would impact your tax return, and you can resubmit the form as often as you like, whenever you like.

Ultimately, the most important thing is that you’re making an intentional choice. If you’re getting a tax refund, make sure it’s because you want one.

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