Is Your Tax Refund Too Big?
You may be familiar with the excited exclamations of “I’m going to do this with my tax return,” or “I’m going to buy that with my tax return!” at tax time.In fact, you may even have expressed a similar sentiment yourself in the past, but have you ever stopped to think that maybe a big tax return isn’t a good thing? This year, the average taxpayer will receive a refund of $2,893. While that’s certainly a nice bump in cash flow, a lot of people look forward to it as a chance to splurge, pay down debt or add to their savings. But those people could have had that money all year long, if they had only withheld less of their paycheck.
Getting a big refund just means that you gave the government an interest free loan for a year.
A lot of people view their tax refund as a nice cash windfall, but if you had withheld less of your paycheck, you could have put that money in a savings retirement account to accrue interest throughout the year, or invested it in some other interest earning program.
While there is no right or wrong answer to how much of a refund you should aim to get back from the IRS, we know it can be tricky to estimate, and we want to help you figure out the best way to get the most of your money. However, it’s definitely worthwhile to regularly evaluate your with-holdings, and here’s why:
Major Life Changes
You may be used to receiving a tax refund – after all, 82% of American taxpayers consistently receive one – but a significant life change can affect how much you receive, or even if you get one at all. And it can be pretty shocking to find out that not only do you NOT get one this year, but that you owe money. Marriage, divorce, the birth or a child, the adoption of a child or a drastic change in your income should trigger a review of how much you have withheld from each paycheck.
Look for Patterns
While a major life change should evoke an evaluation of your with-holdings, if you receive a similar refund each year, you may want to reconsider how much you have withheld, because a consistently large refund means that you’re consistently doing something wrong. We understand that it’s difficult to be 100% accurate when estimating with-holdings, and we also understand that the last thing you want to do is owe the IRS at the end of the year, but withholding too much may not be the best thing for your long-term financial health.
According to one expert, a good place to be is owing a little bit, or getting a little bit back. Where’s a good place? According to the same expert, keeping your refund under $1000 is a good start.
Know Your Saving / Spending Habits
Some people believe that they wouldn’t be able to save that money if it didn’t come in a lump sum at the end of the tax year, and they view their tax refund as a forced savings. While we understand this – after all, everyone has their own way of doing things – if your refund exceeds $5,000, we encourage you to put 45-50% of it toward an IRA or other retirement savings account. Put the other 45-50% toward your debt (if you have any), and spend the remaining 5-10% on yourself, as a reward.
Also, consider the big picture first: do you look forward to a large tax refund but struggle to meet your savings goals on a monthly basis? If you find that you spend a lot of money but never have enough to set aside for the future, it’s time to revisit your withholding (and reevaluate your spending habits, too).
Food for Thought
Tax with-holdings are just an estimate of how much you’ll owe that current tax season, and it may take a few years before you’re finally able to find that “good place” mentioned above. It’ll also take a reevaluation of your current lifestyle and spending habits to determine what amount of withholding is best for you. For help with reevaluating your with-holdings so that you can maximize your earnings, visit http://www.irsallstar.com/our-services#15 or call 877-254-4254 today.