If you’ve been watching any TV at all, you’ve likely figured out it is tax season again. Between the tax preparer advertisements and businesses trying to take advantage of your tax refund, you can’t escape the fact that it is time to file your tax return yet again.
Filing your taxes is usually a welcome surprise for many people. After all, it means it’s time to collect their annual tax refund. Some tax refunds are thousands of dollars while others are only a few hundred. Not everyone is happy about filing their taxes, though. There are some people who actually owe money when they file their taxes. They have no real incentive to rush to file their returns at all. However, using the right software for tax help is important. We use and recommend TurboTax or HR Block to maximize your refund guarantee your return’s accuracy.
You would think getting a tax refund is a good thing. Likewise, you’d think having to pay more to Uncle Sam when you file your tax return is a bad thing. However, that’s not always the case. In fact, I’d argue getting a large tax refund isn’t a good thing at all. Here’s why.
Large Tax Refunds Aren’t Something to Celebrate
Large tax refunds feel great. It’s awesome to get an infusion of cash into your monthly budget. Sadly, tax refunds are usually wasted whether you get a few hundred dollars or a few thousand dollars. A smaller tax refund may not seem like a lot of money so you spend it on something you feel like you deserve, like a new television.
A larger tax refund in the thousands of dollars is a huge deal. Many people quickly blow that money on the down payment for a new car or by booking a vacation for the family. This bad behavior alone should be a good enough reason to quit getting a tax refund. If you aren’t convinced, here are a couple more reasons.
When you get a tax refund, what really happened is you gave Uncle Sam an interest free loan throughout the previous year. Each paycheck, you have a portion sent to the government to pay for your federal taxes. If that amount is too high, Uncle Sam keeps the money until you file your tax return. The best part for government is they don’t have to pay you interest on that money. Whenever you borrow money, you have to pay interest. Yet, when you loan money to the government, they don’t.
What to Do Instead
Instead, you can keep that money and put it in a savings account and earn interest on it throughout the year. Then, when you file your tax return, you can take it out and spend it how you please. Of course, there are more responsible things to do with the money.
Instead of letting Uncle Sam borrow the money, you should be using that money throughout the year. If you would get a $2,600 refund and are paid biweekly, that means you could have an extra $100 in every paycheck without owing money at tax time. Using the money doesn’t necessarily mean spending. Instead, you could be using that extra money to keep from slowly going deeper into debt. If you aren’t spending more than you earn, you could use the money to pay down existing debt. If you have no debt at all, you can invest that money to help toward your retirement.
How to Fix Your Withholding
So now that you understand why getting a large tax refund is bad, what do you do to fix it? The answer is easier than you’d think. If you have a traditional job, you filled out a form when you were first hired that determined how my federal income tax would be withheld from your paycheck. The form, called a W-4, can be filled out again at any time to adjust your withholding on your paycheck.
In fact, you can print off the form yourself and fill it out at home without the pressure of filling it out in your company’s human resources office. The form can be a bit confusing if you don’t understand tax lingo. Read through the instructions slowly a few times to see if you understand how it works. If you can’t figure it out, consult your accountant or financial adviser. Either should be able to help. After you complete your form, take it to your payroll department or human resources department to get your withholding adjusted.
Once you adjust your federal income tax withholding correctly, you’ll start having higher paychecks. Make sure you don’t squander that extra money. Find a way to make sure it works toward the goal you desire. Otherwise, you’ll be just as bad off as you would have been if you blew your tax refund on that television or vacation.
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