Tax refunds are always nice, but if you are getting money back every year you're being really nice to Uncle Sam – loaning him money for free. Why not make some adjustments and make that money work for you?
Sometimes unusual events can result in a large tax refund; perhaps you sold some securities at a loss, had a baby or put money into an IRA for the first time. It takes some work to try to estimate our tax bill exactly and adjust withholding during the year and it is not always worth it for a one-time event. But if you find you're consistently getting a tax refund you should consider taking steps to adjust payments to reduce it. Why give your money to the IRS to hold interest-free for you? You could put that money to good use yourself.
First of all, review your withholding status with your employer. You should be declaring either married or single, depending on your status, and some number of dependents. Dependents include yourself, your spouse and your children or other legal dependents. If you are claiming less dependents than you really have then too much tax may be withheld. You can use the IRS withholding calculator to help you figure it out.
Even if your withholding status is correct, your tax situation may cause you to owe less taxes than a typical wage earner of your status. For instance you may have high medical expenses or a lot of mortgage interest and property taxes that result in higher than typical itemized deductions. In this case you should adjust your withholding (increase the number of dependents) so that less tax is taken out. Don't try to adjust it to match your refund exactly, but try to get it in the vicinity. If you find that your tax bill is usually very low or nothing, consider having no federal taxes withheld at all (and perhaps paying a little at tax-time.) Click here to go to the IRS website for more help.
Now, with your extra take-home pay you can increase your 401(k) or IRA contributions. That way you can boost your savings without feeling any difference in your pocketbook.
Some people like their big refunds, and use that money to pay for a vacation or pay off debt. Financial planners will tell you it's not a good spending habit. It is better to save regularly then to loan your money interest-free for a year and wait for the refund.
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