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With tax day fast approaching, many people are counting on receiving a big check back from the Government. While you’re probably looking forward to this windfall, there are reasons why you may wish to minimize your end-of-year refund.
Why Big Refunds are Bad
Taxes are refunded to you when the Government takes too much of your pay each pay period. By overpaying each paycheck, only to get the money returned to you once a year, you are essentially lending the Government money at zero percent interest.
This is money that could have been budgeted for and spent, or invested, throughout the year. Even if you had put the money in a savings account over the year, you still would be better off.
How to Minimize Your Refund
In order to adjust the amount that is withheld for the IRS each pay period you need to fill out/change your W-4 form.
The W-4 allows you to specify allowances or exemptions that you are eligible for.
These can include:
The W-4 form estimates the amount that you would receive from a tax refund. This amount is then distributed over the number of weeks remaining in the tax year, lowering the amount withheld from your paycheck each pay period.
You should also look into filling out a new W-4 every time you have experienced a major change in your life. Examples of this include:
While trying to lower the amount that is withheld in taxes each pay period generally makes sense, it may be prudent to not list all of the exemptions you are eligible for on your W-4.
Why You May Not Want to Claim all Your Allowances
While having too much in taxes withheld can be compared to lending the Government money at a rate of zero percent interest, the reverse is also true.
If you underpay in taxes each paycheck, you end up owing money to the Government. In theory this is great. You could put the money in a savings account, and then at the end of the year pay back the Government while pocketing the interest that you collected.
In practice however this is not a prudent strategy for most people.
Individuals have a tendency to spend money that they have, and forget about longer-term consequences of their actions. Additionally while receiving a refund at the end of the year is exciting, the opposite is also true.
This is why it may make sense for you to leave a few deductions you are eligible for unlisted on your W-4. This ensures that you receive a tax refund, albeit a smaller one, rather than owing money.
What to Do When You Do Receive a Refund
While this advice can be helpful for next year, chances are this year’s tax season will provide you with a large refund.
If you do receive a large refund there are a series of things you can consider to maximize its value. Here are a few ideas to get you started:
Regardless of what you do with your tax refund, it is important that you come up with a plan. A trusted financial planner can help you in the process of creating one.