Why High Tax Refunds Are Not As Good As They Seem
While it’s nice to get a big tax refund every year, there is a danger of thinking of it as a bonus or reward for filing your tax return. Ideally, however, you want to be as close to zero as possible, as there are more efficient ways to use your money other than giving the IRS an interest-free loan every year.
Why don’t you want big refunds
If your income and expenses fluctuate, it can be difficult to determine how much money to withhold for taxes each year. For this reason, it makes sense that so many people choose to play it safe by overestimating their taxes, as this is better than dealing with unexpected tax shortages while paying taxes. That said, that’s a huge amount of money invested throughout the year – $ 2,869 on average for 2019, according to the IRS .
There is nothing wrong with using your tax refund as your actual savings account – especially since the interest rates on savings accounts are nearly zero – but there are simply better ways to use that money, especially if you have debt.
Use the money in an emergency fund, debt or savings
Let’s say you are a lot like everyone else, and you have credit card debt – say, $ 6,270, which, according to the latest figures , is the average for American families. If you got a refund totaling $ 3,000, it all means you missed out on the $ 250 monthly payments, which would almost halve your total credit card debt. And if your card has an annual rate of 16%, you would cut your monthly interest payments from about $ 80 to $ 40, which of course is money spent just servicing the debt, not paying off the principal.
Likewise, if you don’t have a reserve fund that covers your expenses for three to six months, you will need this money at hand. Connecting with the IRS doesn’t give you the flexibility to save money in an easily accessible bank account every month.
Another suggestion is to invest these funds in retirement savings, especially if you have high interest debt. In fact, this is a great opportunity to start saving more – from a psychological point of view, you are no longer used to seeing this amount in your monthly budget. Of course, you still have to keep track of your expenses (i.e. you won’t get any revenue from your annual tax refunds), but this is a good way to seriously consider a 401 (k) or an IRA. fund.
How to stay on top of withholding taxes
Try using the IRS Payroll Checker tool at least twice a year to help you fine-tune your tax withholding so that your refund is closer to zero (thisstep-by-step instructional video walks you through the steps).
Another way to do this is to manually check your payroll and see how much your employer has withheld for your federal income tax, and then predict how much you expect to owe for an entire year (if you get paid twice a month, you would multiplied the amount of the deduction by 24).
If you find that your current deductions need to be adjusted, you can fill out a new Form W-4 – or your employee’s certificate of deduction – and send it to your employer. After that, keep an eye on your next few salaries to make sure the change was applied correctly.
Unfortunately, freelancers have to deal with a more complex situation requiring quarterly monitoring, but you can at least use last year’s tax liabilities as a guide if your workload is stable.