One of the real accomplishments in a financial life is finding the tax withholding sweet spot. Rather than simply trying to increase the size of your tax refund, the goal should be to avoid getting a refund — and maybe even arranging matters so that you owe a little bit (but not too much) to the government. Looking for your tax withholding sweet spot is a great way to boost your ability to use your financial resources throughout the year.
What Can You Do Without a Tax Refund?
Yes, it’s nice to get a big refund during tax time. It feels a lot like a financial windfall, even though it isn’t. As you tote up your tax breaks, and do your best to legally reduce your tax liability, don’t forget to review your tax withholding. Remember that a tax refund represents money that is already yours anyway. A big tax refund means that the government has been using the money as an interest free loan.
Instead of locking that money away to be used as a forced savings plan that yields no interest, you could be putting that money to work. You could invest more in your retirement account, or build up your emergency savings. You could have more in your own pocket each month to save up for a vacation, or to spend on a couple of “fun” purchases. In any case, you could be using the money on you, and maximizing it, rather than letting the government make use of it.
What to Consider When Deciding On Your Withholding
The idea is to reduce the amount of money receive in a tax refund. You don’t want to go too far, though, because the IRS will charge you penalties and interest if you underpay by too much over the course of the year. The trick is to make sure that, if you owe, it is a relatively small amount that doesn’t raise IRS flags. Owing a small amount means that you have been receiving an interest-free loan from the government to use to your advantage.
Many people like to try to arrange the tax withholding so that they don’t receive a tax refund, while trying to get the amount they owe as close to $0 a possible. Some things to think about as you set your tax withholding should include:
- Expectation of outside income: If you expect to make money on the side, it’s a good idea to consider that in your withholding amount. If you aren’t paying quarterly taxes, you will need to make sure that your withholding is large enough to cover other taxes you owe.
- Life changes: Marriage, divorce, family deaths, and births all change the make-up of your home for tax purposes. Keep these items in mind as you adjust your withholding.
- Results from the previous year: Consider the results of your withholding from last year. If you had a refund, consider reducing what you have been withholding. If what you owed was larger than you would like to pay, or if you saw penalties for owing to much, your withholding might need to be increased.
In the end, your tax withholding probably requires a little tinkering. Don’t be afraid to talk to human resources and get a new W-4 to fill out so that you can ensure that your withholding meets your needs.