So, you’ve filed your income tax return, and you’ve received a pleasant surprise: You’re getting a huge “refund”! You’re feeling excited, and looking forward to spending your windfall.
Unfortunately, we have some bad news: While a big tax refund seems exciting on the surface, it can actually be a sign of poor tax planning. Here’s why.
We all owe a certain amount to the IRS each spring, based on the previous year’s income. And of course, things like your number of dependents, tax deductions, credits, and other factors will influence the final amount owed. That’s why you probably pay estimated taxes throughout the year, which are deducted from your paychecks. Then, in the spring, you must calculate your actual taxes due and pay the difference - or in this case, receive a refund.
Receiving a refund essentially means that you overpaid your taxes for the year. Yes, you get the difference back, after filing your return and waiting a few weeks. But wouldn’t it be better to have that money during the year, when you likely needed it or could have used it for better purposes?
And the worst part? You loaned that money to the government interest free. That cash could have been sitting in a savings account, earning interest all this time.
Here’s the best thing you could have done with overpaid income taxes: Throughout the year, you could have diverted that money to a qualified retirement account. Not only would you be saving for retirement; you will reduce your income tax liability for the year, because contributions to retirement accounts are made on a pre-tax basis. So you’d be saving in more than one way!
If you’ve been overpaying your income taxes each year, it’s time to address the problem. Visit your human resources department, and make sure you’re claiming the right number of dependents on your tax forms. And if you know you’ll overpay again this year, ask for lower taxes to be withheld from your paychecks. Devote that money to your retirement contributions instead. Or, if you’re already maxing out your retirement contributions, set up an automatic deposit into a savings account.
For more financial planning advice, give us a call. We can help you learn how to make the most of your earnings now, to work toward a brighter future.