While it feels good to get a big tax refund every year, there is a risk that you will see this as a bonus or reward for filing your taxes. Ideally, however, you want to be as close to zero as possible as there is a better use for your money than giving the IRS an interest free loan every year.
Why don’t you want big refunds
When your income and expenses fluctuate, it can be difficult to know how much money to withhold for taxes each year. This is why it makes sense for so many people to play it safe by overestimating their taxes as it is better than dealing with an unexpected tax time deficit. Still, that’s a lot of money tied up all year round – an average of $ 2,869 for 2019, according to the IRS.
Using your tax refund as a de facto savings account isn’t necessarily wrong – especially since savings account interest rates are close to zero percent – but there are simply better ways to use that money, especially if you are in debt.
Use the money for an emergency fund, debt, or savings
Let’s say you’re pretty much everyone else and have credit card debt – say, $ 6,270, which according to the US is the average for US families latest data. If you get a total refund of $ 3,000, it just means you missed out on $ 250 monthly payments that would have cut your total credit card debt nearly in half. And if your card had an annual interest rate of 16%, you would have cut your monthly interest payments from about $ 80 to $ 40, which of course is money that is only spent on servicing the debt, not the principal.
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Unless you have an emergency fund to cover three to six months of your expenses, you should have the money on hand. If you let the IRS tie it, you don’t have the same flexibility as if you put the money in an easily accessible bank account every month.
Another suggestion would be to invest those funds in retirement plans, especially if you have high-yield debt under control. This is actually a golden opportunity to save more – psychologically, you are already not used to seeing this amount as part of your monthly budget. Of course, you still need to keep track of your expenses (i.e. you won’t be saved by the annual tax refund), but it’s a great way to get serious about your 401 (k) or IRA fund.
This is how you keep track of your tax withholding
Try the IRS ‘ Paycheck Checkup Tool at least twice a year that allows you to adjust your tax withholding so that your refund is closer to zero dollars (this Step-by-step tutorial video will guide you through the steps).
Another way to do this is to manually review your payroll and see how much your employer withheld for your federal income tax, and then project how much you are likely to owe over the year (if you do twice a month paid, you’d multiply the source amount by 24).
If you find that your current withholdings need adjustment, this is your place to be Fill out a new Form W-4– Take your employee’s withholding tax certificate – and submit it to your employer. Next, keep an eye on your next paychecks to make sure the change has been properly applied.
Unfortunately, freelancers have to deal with one more complicated situation This requires quarterly monitoring, but you can at least use last year’s tax liability as a benchmark if your workload is stable.
