- Average refund amounts
- Tax-free loan to Uncle Sam
- Plan your withholding and estimated tax payments
The IRS reported that approximately 118 million Americans received tax refunds in 2013 averaging around $2,640. The average refund this year is expected to be even higher. If you are among those who received a refund, you are probably celebrating. While some consider a large refund to be a cause for celebration, it’s actually a financial mistake that becomes particularly costly for those who get refunds year after year.
What’s wrong with a refund you, ask? Well, it means that you’ve overpaid your tax all year. That’s actually your own money that you are getting back after making an interest-free loan to Uncle Sam. Such unintended generosity costs you more than you might imagine, even at today’s low interest rates. Consider what would have happened had you, instead, invested $220 per month into an investment program, such as a mutual fund, your credit union, an IRA, etc., rather than overpaying the IRS. Instead of waiting for a $2,640 refund, you would have had that amount plus investment earnings in your account—with no waiting. Or you could have paid off any outstanding debt and reduced the interest you paid during the year. If you historically receive refunds each year, you have forgone years’ worth of investment income or paid far more interest on debt than you needed to.
The alternative is to plan your annual prepayments through withholding and quarterly estimate payments so that they more closely match your projected tax liability for the year. Your withholding is generally adjusted by changing the number of allowances claimed on the W-4 form you turn in to your employer. The more allowances claimed, the less the withholding. However, be careful that you do not claim too many allowances and end up owing Uncle at the end of the year. You should always double-check your payroll deductions once the change has taken effect to ensure that the proper adjustment has been achieved.
If you need assistance projecting next year’s tax and adjusting your withholding allowances, please give this office a call.