Gigantic tax refunds can be exciting at first glance – after all, who doesn’t love getting free money? Everyone loves getting money from the government, but having a supersized tax refund might actually be a bad thing. Here’s a look at why an extra-large tax refund might not be in your best interests, and how to lower it in the future.
What’s wrong with a big tax refund?
First, it’s important to note that a tax refund is not free money from the government. Instead, tax refunds are actually the government’s way of returning the extra money you paid them throughout the year. Essentially, you’ve been lending the government money all year, and they’re now paying up on the loan.
But it gets worse. When you lend the government this money, they return it dollar-for-dollar without paying you any interest. If you landed a $3,000 tax refund this year, it means you’ve given the government a $3,000 interest-free loan.
In addition, consider the other ways you could have used these funds during the year. The extra padding in your paycheck could mean having some breathing room in your budget. If things are extra-tight now, that missing money may have put you over the edge and into debt. Or, maybe you could have that money toward savings.
How do I know if it’s too large?
The average tax refund for the 2021 filing year was $3,039. If your refund is close to or exceeds that amount, it’s probably too large. In this case, it’s usually advisable to take steps towards lowering your refund amount in future years.
Under some circumstances, a taxpayer may be better off with a big refund. For individuals who are unlikely to save extra money throughout the year and would squander it, getting one lump sum as a tax refund once a year may lead to better money choices.
How do I lower my tax refund for next year?
If you’re currently employed, ask your employer for a new W-4. Check your withholding amount, and see how you can adjust it to have less money withheld each month. Proceed with caution, however, as not withholding enough money for taxes throughout the year might result in you needing to pay the deficit to the IRS when tax season rolls around.
Nevertheless, you can decrease the amount of money withheld on each paycheck by adjusting your W-4. It’s advisable to speak with an accountant and/or your tax advisor to ensure you’re making the best choices on your form.
In short, free money from the government is great for everyone. But a large tax refund is not free money – and it’s usually bad news.
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