The average tax refund is more than $2,000. While it may seem pretty awesome to get that big check in the mail, it’s actually an indication that you may be overwithholding.
Overwitholding means you’re having your employer take out too many taxes from your paycheck, essentially giving the federal government an interest-free loan for the year. Underwithholding means that, when you file taxes, you owe the Internal Revenue Service (IRS) money.
If you’re getting a tax refund, ask yourself two questions:
- Do you have credit card bills?
- Do you have an emergency fund to tide you over for a few months if you become unemployed?
If you answered “yes” to the first question or “no” to the second one, getting a tax refund is not such a good deal. The refund is money you could have used all last year to pay off bills and to beef up your emergency fund.
The good news about your refund is that you can use it right now to address those issues. So, tempting as it is to treat yourself when that check comes in from Uncle Sam, use it to relieve some financial stress instead.
To break even, Bankrate.com advises looking at last year’s tax bill. If the amount you had withheld was close and you haven’t had major lifestyle changes, such as getting married or having a baby, then you’re probably safe to leave your payroll withholding the same. If you owed a lot or received a large refund, then you might want to adjust your withholding.
Adjusting your W-4
The more allowances you claim on your W-4, the less income tax will be withheld. The fewer claimed, the larger the withholding amount.
If you’re getting a large refund, visit your employer’s payroll or human resources department and change your W-4 form, which establishes how much your employer withholds for taxes each paycheck. Use the IRS Withholding Calculator and the tax form you just completed to answer its questions, and see how adjusting your withholding affects your take-home pay. You could see a few hundred dollars more each month by increasing your allowances.
Now it won’t help much if that extra money just slips through your fingers. So take one more step, and set up direct deposit so that newfound cash goes to your credit union emergency fund account every payday. Trust us—a full rainy day fund feels a lot better than a once-a-year tax refund.
Keep in mind that everyone’s tax circumstances are different. Work with an independent professional tax adviser or a tax specialist at your credit union before making tax-related decisions.