Around this time of year you see lots of ads, commercials, and media publicizing tax refunds. They promise a certain percentage back, they tell you about special programs, and they tout about the millions in refunds that were handed out last year. And it’s enticing; the average Tax Return last season was almost $3,000. Businesses know this as well, they “discount” TVs, laptops, and other desirables knowing your getting ready to receive a large sum of money.
But it’s not a good thing. Basically you’ve given the government a nice loan over the year, and they returned it without interest. While it may seem nice to get a chunk of cash at once, if you have the discipline, you could do more throughout the year by getting that spread across your paychecks. That money could have grown through saving or investing. It could’ve been used over the year to pay off existing debt faster. It could help out with childcare costs and other recurring expenses.
For example, let’s say you were to get $2,500 for your tax refund. Now instead of getting that in a lump sum because you’ve overpaid the government throughout the year, think about what you could do with an extra $104 per bimonthly paycheck. If you invested that at 5% over the year you’d earn $125. Or let’s say you have a credit card that you’re making minimum payments on. Credit cards have an average an 18% interest rate; it’d possibly take you years to pay it off. If you added an extra $100-$200 every month, you’d increase that process exponentially.
The goal every year should be to get as close to breaking even as possible. Get to the point where you are receiving very little or paying a small amount. If you have to pay too much then you’ll get penalized by the government so don’t get greedy. The way you adjust how much Uncle Sam takes from your paycheck every month is on your W-4 form. Some companies, like the one I work for, have this online and you can change it at will. Some you can only change once a year or after a major life event (Marriage or having a baby). Claiming more exemptions for dependants will lessen the taxes taken out every pay period. The opposite is also true, the fewer the exemptions the more that will be taken out.
Only adjust this if you’re getting a large refund and you have a plan on how to best use your extra money. Otherwise blowing it on non-essentials really won’t help you reach your financial goals. Also adjust if you’ve had a life event and a new dependant to claim. Check out the IRS withholding calculator on the irs.gov website to get a more accurate of look of what the changes could look like. Make a plan, a budget, and follow through as you make changes.