Don't Get A Refund: Tax Edition

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My father always tried to get his tax liability to zero.

He wanted to either pay no tax or receive a refund of $0.

I never truly understood this goal until I started paying my taxes!

When managing your finances, understanding how to handle your taxes can make a significant difference.

Many taxpayers look forward to a hefty refund check each year. Still, rising interest rates should make you consider why paying just the right amount of federal taxes throughout the year could be more beneficial.

The Cost of Overpaying Taxes

A tax refund might feel like a windfall, but it’s actually a return of your own money that you’ve overpaid throughout the year. Essentially, you’ve given the government an interest-free loan. Instead, if you had kept that money and invested it, especially in a high-interest environment like now, you could have earned additional income on those funds.

For example, let’s say you receive a refund of $1,000. You just gave the government an interest-free loan of $1,000. If you had kept and invested that $1,000 at 5% for a year, you would have $1,050, not including any compounding! (Of course, you’d owe some small tax on that $50 too.)

Reducing Your Tax Liability

There are several strategies to reduce your tax liability and keep more money in your pocket throughout the year:

1. Maximize Retirement Contributions: Contributions to traditional 401(k)s and IRAs can reduce your taxable income and grow tax-free until retirement

2. Health Savings Accounts (HSAs): If you have a high-deductible health plan, contributing to an HSA can lower your taxable income and provide tax-free money for medical expenses

3. Adjust Your Withholdings: If you consistently receive large refunds, adjusting your W-4 form with your employer can decrease the amount withheld from your paycheck, increasing your take-home pay. Use this handy calculator from the IRS for more info!

Data on Tax Refunds vs. Owed Taxes

Interestingly, IRS data indicates that almost 63% of taxpayers received a refund on their 2022 taxes. However, a growing number of people owe taxes each year. As of the end of 2022, 18.6 million individual taxpayers owed the IRS $316 billion in overdue taxes.

This shift suggests that more taxpayers are managing their withholdings to avoid overpaying. I’m one of them, and now realize why a refund is something I want to avoid.

Of course, you don’t want to withhold so little that your tax burden becomes unbearable around April of next year!

Remember, just like my father always tried to do, the goal is to break even, where you neither owe a significant amount at tax time nor receive a large refund.

I didn’t do the best job this year and wound up owing a net amount of $2,400. But I earned way more in interest throughout the year. I was anticipating the extra amount owed.

Taking control of your tax withholdings helps you make your money work for you throughout the year, rather than waiting for a refund that could have been earning interest.

It’s a simple step that can positively impact your financial health.

By understanding and applying these strategies, you can optimize your tax situation and ensure that your money serves you the best it can throughout the year.

Remember, a refund is money that you loaned to the government interest-free. Owing tax means you kept what you earned and earned more from it.

And that’s worth the effort.

Save On,

Chris