Q: I’ve filed my taxes, and I’ll be getting quite a sizable refund this year. I love getting free money in my checking account, but I’ve heard this may not be a good thing. Am I doing something wrong?
A: Everyone loves getting money from the government, but your concerns are absolutely valid. Let’s take a look at why an extra-large tax refund may not be in the taxpayer’s best interests, along with how to lower a refund in the future.
What’s wrong with a big tax refund?
First, it’s important to note that money back from taxes are not “free money” from the government. A tax refund is actually the government’s way of returning the extra money you paid them throughout the year. Essentially, you’ve been lending the government money all year, and they’re now paying up on the loan.
But it gets worse. When you lend the government this money, they return it dollar-for-dollar without paying you any interest. Contrast this to any kind of consumer loan, in which the borrower pays a percentage of interest on every payment they make toward the loan. If you landed a $3,000 tax refund this year, you’ve given the government a $3,000 interest-free loan!
Finally, consider the various ways you could have used these funds this year. The extra padding in your checking account could mean the difference between just making it through the month and having some breathing room in your budget for stress-free money management. If things are extra-tight now – as they are for many – that missing money may have put you over the edge and into debt. You could have been investing that money and watching it grow. Or, maybe you would have put that money toward saving for a short- or long-term goal. Instead, that money went to the IRS, month after month, and it’s just now being returned to you.
How do I know if my tax refund is too large?
The average tax refund for the 2021 filing year was $3,039. If your refund is close to this amount, or it exceeds it, it’s likely too large. Make sure you take steps toward lowering your refund amount for the next tax year so you can put those funds to better use.
However, under specific circumstances, a taxpayer may actually be better off with a bigger refund. For individuals who are unlikely to save any extra money throughout the year and would squander the extra funds, a bigger tax refund might be the better choice. These taxpayers may find it easier to make responsible money choices with a lump sum at year’s end as opposed to smaller sums each month. If you fit into this category, consider keeping your refund on the large side.
How do I lower my tax refund next year?
If you think this year’s tax refund was too large and you want to lower next year’s amount, you’ll need to make some changes now.
If you’re a salaried worker, ask your employer for a new W-4. Check your withholding amount to see how you can adjust it to have less money withheld each month, and more money in your pocket throughout the year. Claiming more allowances on your W-4 will decrease the amount of money withheld on each paycheck. You may want to speak with an accountant to make the best choices on your form.
Everyone likes getting free money, especially when it comes from the government. But a large tax refund isn’t free – and it’s usually not good news. Use this guide to learn about why a large tax refund may not be in your best interests, and how to change it going forward.
Have you voluntarily lowered your tax refund? Tell us about it in the comments.