This week, I’ve estimated my federal and state (Michigan) taxes through the end of the year and project that I will receive a $100 federal refund and owe less than $10 to Michigan. While everyone else is excited and posting about how they used their tax refund money next spring, I’m hardly going to be disappointed. Why? Because I already got to use my “refund” every single month this year!
Why It Works For Me
Rather than letting the IRS have the use of my money, I prefer to minimize my withholding as much as possible to only just cover what I will actually owe for the year. This works for me because I budget and track every single dollar of my money on a regular basis. This method will not work for someone who lives paycheck-to-paycheck and spends everything that they earn.
Decreasing my tax withholding may mean not having that extra chunk of money later, but it means that I have more money each month to use to allocate among my financial goals, such as contributing to my Roth IRA, 529 college savings plans for my kids and HSA accounts. Ironically, all of these will decrease my future federal income tax, so it’s a double win for me!
Do you anxiously await your tax refund with big plans of being able to buy something that you have really, really wanted for a long time (like since last tax refund-ha!)? Just realize that intentionally keeping your tax withholding high enough that you know you’re going to get a significant amount of money back after you file your taxes is the same as saving for this expense with each paycheck, except that you don’t get to earn interest and don’t have the ability to access your money until your taxes are filed. Likely that will be over a year after some of the taxes are withheld.
It’s Not Income!
While many people might prefer to have that large refund in the spring and that’s completely alright, I just ask one simple thing:
Do not call your tax refund income.
Income is the money you already received for your hard work during the entire year, your tax refund is a reimbursement from the government of your own money. You overpaid your taxes and now they’re returning the remainder that you didn’t end up actually owing to them.
Is It Right For You?
With that in mind, consider carefully how you want to spend this money and whether you really want to keep using this savings method or if you would be better served by controlling that money on a month-to-month basis by reducing your withholding amounts.
If you’re interested in reducing your withholding (and therefore future tax refund), be sure that you are:
- Budgeting – A budget is simply a spending plan for your money. By assigning a job to your expected income, you’ll be less likely to blow the extra money on eating out and clothes.
- Tracking your expenses – Keeping a list of everything that you spend by category will enlighten you about where exactly your paycheck goes every month. This knowledge will empower you to spend your money on things that are important to you.
- Knowledgable about taxes – You need to have a good basic understanding of taxes to make sure that you can estimate how much your taxes will be during the year. You’ll also need to understand how to calculate the number of withholding to use for federal income tax purposes. We covered tax basics in our previous class TX301: Income Tax Basics. Payroll taxes and a resource for estimating your federal taxes will be presented in future classes over the next couple weeks. You will need to check whether your current withholding rate is sufficient every few months or when you have any significant income changes to make sure you aren’t going to owe a significant amount.
Whether you decide to keep your sizable tax refund or adjust your withholding to get a little extra each month to reach your goals more quickly, making that conscious decision is what is really important.
There’s no right or wrong way; you’re doing it “right” if you’re being intentional with your money and using your money as a tool to achieve your financial goals.