How many of you have access to interest-free loans? Wouldn’t it be great to buy a house or take out a student loan and not have to pay any interest? That would be a dream for everybody, but lenders would never agree. Just go ask your bank if you can take out an interest-free loan and you might get laughed out of the building. Interest-free loans are normally reserved for family and friends, and even then, that is asking a lot. So if lenders won’t offer an interest-free loan then why the heck are you?
What I am referring to is that huge tax return people receive. Since it is close to tax season, this is a public service announcement explaining the silliness of hoping for a larger refund, or even worse, planning for one. A tax return from the government is a refund of money you have rightfully earned yet overpaid in taxes throughout the year. This is not some gift that the government is giving out of the generosity of their heart, but returning money you are rightfully due at a later date. This means from the time the money was taken out of your paycheck to the time you finally process your refund, the government has access to that money interest-free! But that is okay since we all know how effective our government is at spending money wisely and efficiently *dripping with sarcasm*. Huge tax refunds are a pleasant surprise, but they are signaling a larger problem.
In 2015, the average tax return was $3,1201! That is a huge number. Think about what you would get if you received the following interest on that.
1% = $31
3% = $93
5% = $155
10% = $310
I wouldn’t mind the extra money in my pocket to buy whatever I please at a time when I might need it throughout the year. This interest benefit is without even factoring in how people spend a “windfall” like a tax refund vs. how they spend their common paychecks. When you receive a huge refund it makes you believe this is extra money and you should spend it on a new car, vacation, or other big ticket item that you might not justify throughout the year.
At this point, I hope it is apparent that huge tax refunds are not something to strive for, and if you are going to give away free money, then please let me know where to sign up. Now that I have expressed my disbelief and everyone thinks, “Okay, Matt, we get it”, I will actually try to assist in lowering your tax refund. Please know I am not saying you want to owe money during tax season – that is tough to budget for, and there are even possible penalties (see the government is not dumb either) if you owe too much. What I am recommending is that you work towards a refund of a couple hundred dollars, maybe a little more, as a buffer. The lowest you can get to 0 without going under will win you a large teddy bear (disclaimer: no it won’t unless you are buying it with your brand new interest!). So how do you lower how much taxes you pay if you received a huge refund?
First, look at what you received last year and see if anything major changed in salary, marriage status, dependents, etc. If these have changed very little then you have a strong estimate of what you will owe and can compare against how much taxes are being removed from your paycheck. One thing I like to do is estimate my withholdings throughout the year using the IRS calculator https://apps.irs.gov/app/withholdingcalculator/. I try to check in the middle of the year to see if I am paying too much or too little. If I am paying too much, then I change the allowances on my W4 and pay less in taxes. If I am paying too little, then I lower the allowances. The allowances have rules around them that will need to be reviewed for your specific circumstances but at a minimum you can change between 0 and 1. This adjustment can be done mid-year and is the easiest way to align your taxes paid to what you should be owing. You are welcome.
All of this is not an exact science. I have routinely received higher refunds than I would like, but still much lower than the average, due to getting married mid-year, getting deductions from going back to school, or opening a 529 account. These changes make it harder to estimate but I will continue to work towards zero. Let’s all agree that the government doesn’t deserve any more of our hard-earned money and end the silliness of celebrating large tax refunds.
FutureMillenniares 