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Congratulations! You got a tax refund – the government ever so kindly returned some of your hard earned money to you! How nice of them to hold on to it for you all year, waiting for the right time to give you back what you so generously lent them… wait a minute…
If you’re pausing at this idea, you should – getting a tax refund sounds nice, but in reality you just gave a zero interest loan to the government. This neat little trick (sorry, illusion) is what the IRS likes to bait you with come tax time – do your taxes and we’ll give you free money!
The sad truth is that it was your money all along, and you could have used it all year for any number of things – at the very least you would have had a little more cushion in your paycheck, and beyond that you could have saved it, invested it, or spent it at your discretion. By keeping your money and returning it to you all at once, they’ve effectively tricked you into believing this is “extra” money, when in fact it didn’t need to be held by them in the first place.
The second part of this magic act is the very real temptation to spend it on something you don’t need – now that I have this big chunk of change, I can finally buy that thing that I couldn’t afford! Before falling for this trick, ask yourself a couple of questions; am I in credit card debt? Do I have student loans or a car payment? If the answer to any of these is “yes”, then the truth is you can’t actually afford to spend this money, despite the clever trickery of calling it a “refund”.
If you are in debt, then the best use of this money is to pay something down – maybe you have a few thousand dollars left to pay off on your credit card, or you can knock out a small student loan with your refund. While the magic of the refund is that they’re returning your own money to you, it can actually benefit you if used wisely.
If you’re free and clear, then consider using this money for something you need rather than want – do you need new tires on your vehicle but have been putting it off? Do you need to get your wisdom teeth out but couldn’t afford it? Using this money for something important is a better use of your withheld funds than that fancy new purse or another jet ski (sorry, Kenny Powers).
If you’re out of debt, don’t need anything, and you still have some cash leftover from your refund, consider putting it in savings or investing it – what looks like a small amount of money now can grow into something big with time. Challenge yourself to start a new habit, where any “extra” money you get (birthdays, Christmas, etc.) goes straight into your savings or investments, and watch it grow; it’s incredible what time and a little bit of compounding interest can do.
Now that you know the secret behind this magic trick, you might be wondering how you can avoid it in the future, and the answer is simple – fill out a new W-4. Today. If you got a significant amount of money back, then increase the number of exemptions. If you owed money, then decrease them. Zero exemptions indicate that the most tax will be withheld, while you’ll see more and more in your paycheck as you increase the number of exemptions – make sure to read through the instructions or use an online calculator for help if you aren’t sure what to put down.
When it comes to taxes, the goal should always be to break even each year, meaning you would owe no money, and get no refund. This might not seem very exciting, but it means you get to use all of your money all year long, rather than the government holding onto it for you and returning it later with no interest. Alternatively, it also means you don’t wind up owing a bunch of money come tax time – you always want to err on the side of caution by getting a little back, but if you’re getting thousands of dollars, it’s time to take a look at that W-4.
What many people don’t realize is that you can fill out a new W-4 at any time – my HR rep can attest to my vigilance in this area, as I think I’ve adjusted mine 3 times already this year. The beginning of the year is always a good time to adjust, as well as in response to your taxes. This year was our first time writing off a full year of mortgage interest, and I withheld too much, so I adjusted my W-4 to increase my exemptions.
Other times to review your W-4 are when you get married, have a child, you or your spouse change jobs, any significant changes in salary, divorce, or a change in your tax situation. Essentially, all of life’s big moments should be accompanied by a review of your W-4, and you are entitled to change this as many times as you want, even if HR rolls their eyes when you walk in with another one.
For those of you out there who are contract employees on a 1099 basis, consider setting up an account where you put away money throughout the year so that you aren’t stuck with a big bill you can’t pay come tax season. I’ve made that mistake myself, and you can make your life a whole lot easier by setting some money aside each paycheck instead of trying to come up with all the money at once – you can even put it in a savings account where it’s making you a little bit of interest while you’re waiting for tax time.
When it’s all said and done, taxes are no one’s favorite subject, but educating yourself on the tools available to you can give you the advantage. I encourage you to take a closer look at what you’re getting back this year, use it wisely, and change your W-4 to reflect your current situation. A magician never reveals their secrets but magic was never my thing – and the numbers don’t lie.