The person who does our taxes always seems to come up with ways for us to get a bigger refund each year. But, I’m not so sure getting a big refund each year is the way I should be planning my taxes. Am I wrong?
While the feeling of getting that big fat refund from the IRS is hard to beat, when you realize that all it represents is a repayment of an interest free loan you made to the government you might not revel in it quite as much. The average refund, which is the amount of taxes over-paid to the government, is about $3,100. That translates into $250 a month that could have been used to pay down debt or add to your retirement account.
In essence, refunds are a lost earning opportunity. Over time, this can add up to thousands of dollars in additional interest costs on debt or lost interest earnings on savings.
Ideally, you want to plan your taxes so you don’t receive a refund, which requires a constant monitoring of your financial situation. Any change that results in a decrease in your adjusted gross income, like a new mortgage, a new birth, starting a business, etc., could lower your tax bill, which should prompt an adjustment in your withholding. A boost in income could also warrant an adjustment so that you won’t be assessed an under-withholding penalty.
If you expect to get a refund each year, you need to have your withholding changed to reflect your current earnings and tax status.
- Your W-4 form provides you with a guide to determine the number of allowances you should claim so that the right amount of tax is withheld.
- Your tax professional should be looking for ways to maximize your monthly take home, not your annual refund.
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