The average tax refund is more than $2,000, but if you’re getting that much back every year then you may be overwithholding by giving the federal government an interest-free loan for the year. Underwithholding is when you file taxes, you owe the Internal Revenue Service (IRS) money.
Sometimes it’s confusing to know which is the right W-4 withholding for you. Here are some guidelines that can help you explain what might be best for you:
Withholdings
If you’re getting money back, ask yourself two questions:
1. Do you have credit card bills?
2. Do you have an emergency fund to tide you over for a few months if you become unemployed?
If you answered “yes” to the first question or “no” to the second one, getting a tax refund may not be the best idea. The refund is money withheld that you could have used all last year to pay off bills and to beef up your emergency fund.
The good news about your refund is that you can use it right now to address those issues. As tempting as it is to treat yourself when that check comes in from Uncle Sam, use it to relieve some financial stress instead. One of the easiest ways to do this is to plan ahead of time, before the refund comes. Start with bills you can pay down, and if you have money left over consider starting a savings account for emergencies.
To break even, Bankrate.com advises looking at last year’s tax bill. If the amount you had withheld was close and you haven’t had major lifestyle changes, such as getting married or having a baby, then you’re probably safe to leave your payroll withholding the same. If you owed a lot or received a large refund, then you might want to adjust your withholding.
Adjusting your W-4
Start with the basic facts: the more allowances you claim on your W-4, the less income tax will be withheld. The fewer claimed, the larger the withholding amount.
If you’re getting a large refund, talk to your employer’s payroll or human resources department and change your W-4 form, which establishes how much your employer withholds for taxes each paycheck. Use the IRS’ tax withholding calculator at irs.govand to answer its questions and see how adjusting your withholding affects your take-home pay. You could see a few hundred dollars more each month by increasing your allowances.
Now it won’t help much if that extra money just slips through your fingers. Take one more step and set up a direct deposit each paycheck that sets aside money to your Liberty Savings account. This is a great way to keep that emergency fund going. Trust us—a full rainy day fund feels a lot better than a once-a-year tax refund.
Keep in mind that everyone’s tax circumstances are different. To make sure your adjustments are working best for you, make sure to work with an independent professional tax adviser before making tax-related decisions.