Why a big tax refund may not be as great as you think. Are you awaiting for or have you already received a big tax refund? Most people who withhold taxes thru W-2 wage payments receive money back from the IRS. I recently heard someone say with pride "I made out good... the government is paying me $x,xxx." Well, sorry to tell you this but you didn't make out so well. A tax refund is simply your money that you overpaid- being returned to you. When you overpay your taxes you essentially just provided the government with an interest-free loan thru the course of the year. That is so generous of you.
Your goal should be to withhold as close as possible what you will end up owing. Some people liken their refund to a "forced savings" plan, which can be understandable if living paycheck to paycheck. For perspective though, a $3,000 refund equates to $250 or so that you can have in your pocket each month to use. This is why it is advisable to adjust your W-4 withholding each year after tax filing. The W-4 is a simple form you can use to provide to your HR/payroll department at work.
I realize that it is difficult to nail this number each year due to unexpected tax events that happen- children are born/leave the house, inheritances, bonuses, large deductions, etc. Your CPA can help suggest your withholding or your can estimate using a calculator.
Self Employed and Don't use a W-4 Withholding
If you are self-employed don't forget that you need to pay estimated quarterly tax payments (due on the 15th of April, June, September and January) in order to avoid penalties. These are to be 90% of your current year or 100% shown on your prior year's tax return filed, whichever is smaller.
You have a refund, so what should you consider now?
Adjust your W-4 withholdings for the current tax year, as discussed above.
Pay offyour credit card, student loans or other high interest rate debt.
Build up your Emergency Fund. Rainy days will happen.
Earmark your returnfor a "sinking fund," (a known expense) such as a car purchase or upcoming taxes.
Invest it. Too many reasons why this is a good idea to list in this post, call me.
Okay-the last suggestion, which is rather common (and I have been guilty of in the past): use for a vacation!
All the best,
Luke A Fields, CFP®
Any opinions are those of Luke Fields and not necessarily those of RJFS or Raymond James. You should discuss tax or legal matters with the appropriate professional.
About Stewardship Cents
Stewardship Cents exists to Educate, Entertain and Enhance the financial wisdom of all who read it. Everyone needs to be wise with what has been entrusted to them and common sense can help us be good stewards of all that we have. Stewardship is a belief of responsible overseeing and protecting of important resources. Luke Fields is Vice President of Foley & Foley Wealth Strategies, An Independent Firm, that has been based in Worthington, Ohio since 1981. A graduate from The Max M. Fisher College of Business at The Ohio State University, Luke is a CERTIFIED FINANCIAL PLANNER™, holding his Series 7, 66 and Ohio Life, Health and Variable Annuity Insurance licenses. He resides in Columbus, OH with his high school sweetheart, Beth and their three children. Luke is an active member of his church, serving in leadership and finances.
Follow additional insights and connect on LinkedIn, Facebook, his blog or Twitter.You can always reach him with comments or questions at: luke.fields@raymondjames.com.
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