3 Reasons You Don’t Want a Big Tax Refund Next Year
Key takeaways
A big tax refund means you’ve loaned the government your money—interest-free.
Directing your tax refund toward retirement, emergency savings or paying down debt may be a better use of your money.
Adjusting your tax withholdings can prevent large refunds in the future.
What did your tax bill look like this year? Did you get a big check back from Uncle Sam?
Most taxpayers end up getting a refund. But before you release the balloons and throw the confetti, it might interest you to know that a giant refund isn’t cause for celebration.
Here, we’ll explain why you don’t want a big tax refund, what you could be doing with the money instead, and how you might prevent yourself from getting a refund next year.
Why you don’t want a big tax refund
The simple reason you don’t want a tax refund is that getting one means that you’ve just loaned the U.S. government your money—without making any interest.
It’s not the smartest financial plan, especially if you’re lugging around credit card debt, student loans or any other kind of debt. Instead of loaning that money to the government, you could be making that money work for you.
3 ways to put your money to better use
Here are three things that your refund could have gone to throughout the year. And let’s assume you had a $2,800 refund, since that’s about how much the average refund was for tax year 2022.
Save for retirement. When you let the government sit on $2,800 for up to 12 months, you’re giving up a huge opportunity for savings. What if, instead of waiting for the IRS to refund you your overpayments, you bumped up your 401(k) contributions by a percentage point or two? Over several decades, that change could earn you a more comfortable existence in retirement. And while there will certainly be ups and downs in the market, if you’re a long-term investor and you don’t put that money in until you get your refund, it’s like losing a year’s worth of appreciation.
Build up your emergency fund. That $2,800 is no small chunk of change. If you had an unexpected car expense or medical bill, you’d probably be happy you had it. Emergency funds don’t spring up overnight—you have to put money aside, little by little. If you don’t have one, an extra $233 a month would help start to fill yours out. Generally, it’s smart to have six months’ living expenses socked away in your emergency fund.
Pay down debt. An extra $233 a month could help to pay off debt—or to keep yourself from getting into debt in the first place. Many Americans carry a credit card balance. By dedicating that extra money to paying down card balances, you could save a significant amount of money in interest payments. Even if your interest rate is not high, keeping your balance low (or nonexistent) is a good idea.
Social Security is an important part of your financial plan.
Your financial advisor can show you how Social Security will work to reinforce your retirement savings. And they’ll show you how it can help you live the life you want in retirement.
Let's get startedHow to reduce your refund
If you got $200 back this year, there’s no need to go rushing to your payroll department to adjust your tax withholdings. But if your refund is $1,000 or more (or the amount is a relatively large percentage of your income), you should consider making an adjustment.
The IRS’s withholding calculator is a great place to start. It requires some information, such as how much in taxes has been withheld so far this year, so you’ll probably want your most recent paycheck handy as well as your most recent tax return. Once you find out what your withholding should be, you can file a new W-4 with your employer, sit back, and wait for a larger paycheck.
If you’re looking for some additional help, a tax professional is a great resource.
This strategy works only if you stick to it
This theory that “money in your pocket is better than money you’re loaning to the federal government” works only if you can put it to good use. If extra cash every month will go toward eating out more often or buying yourself the next iPhone—in other words, lifestyle choices as opposed to financial priorities—then you may be better off leaving your withholding alone. After all, forced savings is better than no savings.
If you do decide to make a change, make a plan for the added money coming your way each month, and commit to sticking with it. One option is to set up an automatic transfer every payday from your checking account to a savings, retirement or investment account—or to your student loan company. Or go ahead and boost your 401(k) contributions by an equivalent percentage. Your future self will thank you later.
Your Northwestern Mutual financial advisor can help
Looking for a personalized strategy to get the most out of your money? Get in touch with your Northwestern Mutual financial advisor today. They’ll start by getting to know you and asking thoughtful questions to understand your financial situation. From there, they can offer practical advice to help you meet your goals.
