Tax Refunds

The average federal income tax refund is over $2,000. Perhaps that's a nice surprise, but it constitutes an interest-free loan to the U.S. government. On the other hand, if you don't have enough taxes withheld and owe more than a pittance on your tax return, does Uncle Sam give you an interest free loan on the money? Of course not, and that's all the more reason why getting a tax refund is probably not a good idea, particularly when you can easily avoid it.

Adjust your withholding exemptions. The trick is to claim the number of withholding exemptions that will result in withholding an amount that is close to what you're going to owe. You may not recall, but when you signed up with the payroll department, you filled out a form that declared a number of withholding exemptions that in turn told the payroll department how much to withhold from your paychecks. In order to adjust your withholding, you'll need to file a new W-4 form with your employer. It looks daunting, but the instructions are actually rather helpful.

Since a lot of things can change with respect to your income tax situation, a couple of times a year you should check to make sure that there's an adequate amount being withheld. One of those times should be in October or November of each year, so there's time to increase the amount withheld if it looks like you're going to come up short.

In addition to receiving a big tax refund or having to pay a lot of money with your return, there are a few other situations that may require you to adjust your withholding, including:

  • Changes in your family status, notably marriage, the arrival of children, or not being able to claim a dependent that you had been claiming (increase or decrease withholding exemptions)
  • Paying out significant medical or other expenses that are wholly or partially deductible (increase withholding exemptions)
  • Buying a home (increase withholding exemptions which will help make those breathtaking mortgage payments)

What to do with your increased take home pay? After you adjust your withholding to eliminate or at least reduce your refund, you'll soon notice a loftier paycheck. It's your money to spend as you wish, but I'd recommend that you don't take your increased take home pay home. Instead, put it away for the future either by increasing your retirement plan contributions at work or by arranging to have the extra money transferred automatically to a retirement or investment account.