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Tax season often brings a familiar ritual: filing your return and waiting to see how big your refund will be. For many households, that refund can feel like a financial bonus arriving just as spring expenses begin to pile up. According to the Internal Revenue Service (IRS), the average tax refund is currently $3,742.
But a large refund also means something else. You may have given the government an interest-free loan during the year.
Instead of sitting with the IRS, that same money could have been earning interest in a savings account, growing in an investment portfolio or helping you reduce debt. Even modest returns can add up when money stays in your own account throughout the year. While refunds can still serve a purpose for some taxpayers, it is worth understanding the opportunity cost.
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Why tax refunds happen
Each year, the IRS issues hundreds of billions of dollars in tax refunds to U.S. taxpayers. Refunds typically happen for several reasons:
- Too much federal tax withholding from paychecks
- Estimated tax payments that exceeded actual tax liability
- Refundable tax credits, such as the Child Tax Credit or Earned Income Tax Credit
- Outdated W-4 forms that don’t reflect a taxpayer’s current situation
Changes like marriage, divorce or a new child may not be reflected in withholding adjustments when you file your taxes, which can impact your refund.
Many people also intentionally over-withhold because they want to avoid owing taxes when they file. Others treat their refund as a type of forced savings plan.
While that approach can help some households build a lump sum, it also means the money wasn’t working for them during the year. So how much could that money actually earn if it stayed in your account during the year? The answer depends on where you keep it.
What your tax refund could earn in a high-yield savings account
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High-yield savings accounts have offered higher interest rates in recent years than traditional bank accounts.
If the average $3,742 refund had instead been kept in a high-yield savings account earning 3% to 4% annually, it could have generated:
- About $112 in interest at 3%
- About $150 in interest at 4%
That may not sound like a huge amount, but it represents money earned simply by keeping the funds in your own account rather than sending them to the IRS through excess withholding.
While rates are still elevated, use the tool below to explore and compare some of today’s top savings account options:
What your tax refund could earn in a CD
Certificates of deposit (CDs) can sometimes offer higher yields than savings accounts, depending on the term. In exchange for locking your money away for a set period, banks and credit unions may offer a slightly higher interest rate than a typical savings account.
Below is an example of what a $3,742 tax refund could earn in CDs with different terms using rates from several top CD accounts Kiplinger has reviewed.
CDs typically require you to keep the money invested for the full term. Withdrawing funds early can trigger penalties, which often equal several months of interest. For savers who are comfortable locking up their money for a fixed period, however, CDs can offer predictable returns and protection from market volatility.
What your tax return could earn in the stock market
The opportunity cost becomes more noticeable over longer periods. Historically, the S&P 500 has averaged roughly 10% annual returns over the long term, though results vary significantly year to year and returns are never guaranteed.
If that same $3,742 had been invested instead of withheld, the potential growth could look something like this:
- 1 year: about $374 in growth
- 5 years: about $2,283 in growth
- 10 years: about $5,963 in growth
This example illustrates how even relatively small amounts can grow significantly over time through compounding.
Of course, stock market investing involves risk and short-term returns can fluctuate widely.
How to avoid overpaying taxes during the year
Taxpayers who want to keep more money in their pockets during the year can take a few steps to better align withholding with their actual tax bill.
- Review your W-4. Updating your W-4 allows you to adjust how much tax is withheld from each paycheck.
- Use the IRS withholding estimator. The IRS provides an online calculator that can help determine whether your withholding is on track.
- Adjust withholding after major life changes. Marriage, children, new jobs or side income can all affect your tax situation.
- Check withholding mid-year. Reviewing your tax situation halfway through the year can help prevent surprises.
- Work with a tax professional if income varies. Self-employed workers or freelancers may need more customized withholding or estimated tax planning.
When a tax refund might still make sense
Despite the opportunity cost, a refund isn’t always a bad outcome. In some cases, refunds are unavoidable or even beneficial.
For example, refundable tax credits may generate a refund regardless of withholding. Also, self-employed taxpayers sometimes overpay estimated taxes to avoid penalties and those with irregular income may prefer a buffer to ensure they don’t underpay.
For households that struggle to save consistently, a refund can also function as a once-a-year financial reset, providing money to build an emergency fund, pay down debt or cover large expenses.
Still, understanding the potential earnings that refunds represent can help taxpayers make more intentional decisions about how much they send to the IRS throughout the year.
