How to Handle Your Tax Refunds
Are you one of the estimated 110 million taxpayers receiving a tax refund? Are you receiving more than the average $2,800? Well, in that case I am sorry. Better luck next time. In fact, if you received any refund, I guess I would say better luck next time. Why would I say that? Do I think it is better to owe? Well that depends.
What Is a Tax Refund… Really?
Think about what it means to receive a refund. It means that you gave more money to the government than you needed to. So all year, every month, as you struggled to pay your bills, missed out on something fun or simply continued paying 16% on your credit cards, your government had the money you needed all along – and it belonged to you!
If you were paying 16% on a credit card and could have sent them the extra money every month instead of “lending” it to the IRS, you would have saved about $200 in interest for the year. So you generously lent money to a trillion dollar agency for free, while you lost over $200 in interest. That seems like a shame.
Maybe you don’t have credit card debt. Great. Do you have a mortgage? A car loan? What about a 401(k)? Whether it is about saving interest or earning a return on your money, the fact is there is no reason to lend it to the IRS for free. They really don’t even appreciate it. It is not extra patriotic or anything. They just have to send it back to you in April anyway.
If you really look forward to the big refund, then maybe you could approach it differently, such as putting the money in a savings account so you have access to it in case of an emergency, but if not, then you will have it for your vacation money or whatever else you use it for.
Here’s the thing. Start talking to financially successful people. You will find that they do not like getting large refunds. Why? Because they realize they wasted the opportunity to make good use of that money for the last year. Now talk to those who are not financially successful. You will find that they love getting large refunds. So now you have to decide, do you want to do what financially successful people do or not? Who do you want to imitate?
Determine Next Year’s Tax Refund and Adjust
Going forward, you should estimate next year’s taxes. How? Just use TurboTax or similar software (which you should be using anyway unless you have very complicated returns). You can start a new return (after you complete your filing this year) but enter estimates of next year’s income and deductions. This will tell you how much you will have to pay by the end of the year.
Now look at your paystub and multiply the amount you have deducted for federal taxes times the number of paychecks you receive in a year (normally either 24 or 26 – but not always). What number do you get? Is it about the same as your fake tax return? If so you are set. If it looks like you will owe a lot, then you will need to have extra taken out each pay period. If you will receive a large refund, then you can add deductions on your W-4 at work so you keep more money. Adjust it until you will be close to zero. If you want to be conservative, try to estimate it so you will get about $500 in refunds. That will provide a little cushion so you are not shocked with a large tax bill.