You have likely heard that you should adjust your tax withholding if receiving a large tax refund has become an annual tradition for you. This will increase the size of your paychecks so that you have more money at your disposal throughout the year instead of giving the government a no-interest loan. Adjusting your withholding can take into account even expected windfalls from refundable tax credits, such as the Child Tax Credit. But it may not be that straightforward.
Proactive versus Reactive Behavior?
Emotion, not economics, is the main driver behind financial well-being, according to financial advisor Tim Maurer, author of “Simple Money.” Some advisors may tell you to remove your emotions from your financial decisions. Relying solely on your feelings tends to lead to less-than-ideal choices. Maurer believes you will be better off if you can “acknowledge [your emotions], recognize them, and plan accordingly.”
How would you feel if you had to write a check to the federal tax agency?
The idea of getting more money in each paycheck by reducing your tax withholding can be appealing. But what happens if you miscalculate and find yourself owing the government instead at the end of the year?
Do you handle small and large windfalls differently?
Think about the last time you received a raise. Did your savings increase or your spending? You might be better off continuing to receive the refund instead of increasing your salary if getting that small bump in pay typically leads to more spending, while larger windfalls like bonuses or refunds typically go toward saving or debt.
Do you have short-term and long-term financial goals?
Whether you decide to decrease your tax withholding or continue to receive refunds, you will be more successful if you put a concrete plan in place for what you want to do with the money, according to Timons. “There are similarities between tax refunds and bonuses,” says Timons. “Unless you are intentional and deliberate, and you already have [a plan] for the money, and as soon as the money hits your account you [execute that plan] right away, it’s likely you will lose the money.”
Frequently Asked Questions
How can I adjust my tax withholding?
With tax withholding, you can anticipate your tax liability for the year in advance. Your employer will require you to fill out a W-4 form when you start working, and you can submit a new form anytime you wish if you undergo a major life event that may affect your allowances. It informs your employer how much should be withheld from your salary for taxes. The IRS provides a helpful online tool that can help ensure you get the right withholding and includes considerations for any tax credits you think you may qualify for.
What is wrong with receiving a large tax refund?
There is nothing inherently wrong or bad about getting a large tax refund, but it might mean that you overpaid taxes throughout the year if you did. The IRS is simply returning that overpayment to you without interest. You could use the money for investments or other money-making efforts if you had paid it to you as income at the time you earned it rather than having it withheld from your paychecks.
Is there a penalty for receiving a large tax refund?
The entire tax filing process is designed to manage income tax increases and decreases. You will only incur a penalty in the case of mistakes or any fraudulent activity in this process if you attempt to play the system or avoid paying taxes entirely.
Do
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Sources:
U.S. Internal Revenue Service. “Statistics of Income Filing Season for Week Ending December 30, 2022.”
National Retail Federation. “Tax Returns: Consumer Plans for 2023.”
Tim Maurer. “Personal Finance Is Actually More Personal Than Finance.”
Source: https://www.thebalancemoney.com/why-big-tax-refunds-are-not-bad-4135481
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