Adjusting Your Withholding If You Receive a Large Refund

Although the experience of getting a large tax refund can be quite nice, many people don’t realize that it’s not optimal. The reason is receiving a large annual refund means someone is actually missing out on a larger total amount of money.

The simple explanation of why that’s the case is if you consistently receive a large refund, it means too much of what you make is being held out of your pay. So even though people often find getting a large refund convenient because they’re able to put it towards a large purchase or paying off a specific debt, it’s important to remember that this money belongs to that individual. By letting the IRS hold it for most of the year, people are turning over the opportunity to earn any interest from it.

 

The Why and How of Adjusting Your Withholding

A simple exercise for seeing the impact that adjusting your withholding can have on your monthly income is to take your most recent tax refund and divide it by twelve. That figure will give you a general estimate of what you could add to your monthly take-home pay. While you do eventually get the total amount back in the form of a refund, receiving it over the course of a year provides the opportunity to invest or at the very least earn a little interest from a savings account.

If you decide that it makes sense for you to adjust your tax withholding, you may have an opportunity if your employer asks about this issue in December or January. But even if they don’t, you can make a change at any time by filling out a new W-4 and then handing it in. The rule of thumb for anyone who consistently receives a big refund is to increase the number of personal allowances. And if you want to make this adjustment because you consistently end up owing taxes, decreasing personal allowances is generally the best way to go.

Since finding the right balance can be a little tricky, you may want to use a withholding calculator to help you out. It’s also worth noting that other times to review your current withholding are when you or your spouse get more than one job. The same is true if you have children, get divorced, buy a home or get married.

Knowing if you need to adjust your withholding is just one example of the type of issue that can directly affect your finances. If you want to be sure that your tax situation is fully optimized, be sure to take a look at our tax return preparation service.