By Steve Davis, CERTIFIED FINANCIAL PLANNER™
Is Your Tax Refund Too Big? What to do now that the IRS is finally giving you your money back
In the 1979 Academy-Award-winning movie Breaking Away, Dave Stohler’s father goes catatonic when his son offers a refund to a customer who wants to return a car to the family’s used-car lot. “Refund?!, Refund?!”, he screams (watch the clip: Breaking Away). These days, shouts about refunds tend to be for joy or relief rather than consternation. Of course, we’re talking about an entirely different type of refund. February is the month when early filers start getting their tax refunds.
According to the IRS, the average tax refund in 2011 was about $3,000. For some, this is a good thing – like the $20 you sometimes find in the pocket of your winter coat after you pull it out of summer storage. For others, it’s the realization that they’re finally getting their hard-earned money back after having “lent it” to the government at zero interest. Remember, your tax refund isn’t some sort of magical windfall – it is money that was over-withheld from your paycheck during the past year.
Your tax refund isn’t some sort of magical windfall — it’s your money, and you worked hard for it. Now that you’ve got it back, do something smart with it.
1. Start an emergency fund. If you don’t have an emergency fund, use your refund to create one for a rainy day. Should you ever lose your job or have the roof blow off the house, you’ll be glad you did.
2. Pay down your debt. Get the monkey off your back and pay down your credit cards, student loans, or any other debt.
3. Refinance your mortgage. Interest rates are at or near all-time lows. Use your tax refund toward closing costs and snag a low rate because it can result in substantial savings.
4. Fund your IRA. If you’re one of the many Americans who have too little saved toward their retirement, consider funding your Roth or traditional IRA.
5. Adjust your withholding. If you don’t have the discipline to save, getting a tax refund can be a nice thing. On the other hand, reducing the amount you have withheld from your paycheck is like getting a raise. To make the change, file an updated W-4 form with your employer; by changing the number of allowances you claim, you can adjust the amount you have taken out of your paycheck. Ideally, you’ll want your withholding to match your tax liability.
If you pay an accountant to do your taxes, they will most likely give you advice with your W-4. If you do your own taxes, many of the tax software programs offer a W-4 feature as part of the software. The IRS also has an online calculator to help.