Most of us hate the hassle of filing our taxes, but we love to get a tax refund. Approximately 75% of Americans got a tax refund in 2022 and the average refund was $4,123 for Texas residents!* But, is a big tax refund bad?
Is a Big Tax Refund Bad?
There’s nothing wrong with getting a large refund but it does mean that you overpaid your taxes during the year. The IRS is just returning that overpayment to you without interest! Receiving a refund might be a good thing if it keeps you from squandering the money away during the year AND if you put your refund to good use when you get it.
A refund is neither found money nor free money. It’s your own hard-earned cash that was on loan to the government! You could have used the money toward investments or other money-making efforts if it had been paid out to you as income when you earned it rather than withheld from your payroll.
What to Change
1. Adjust Your Withholding (W-4)
Your tax refund is often the result of having too much federal income tax withheld from your paycheck. Use the IRS Tax Withholding Estimator to determine the right amount based on your income, dependents, and deductions. Then, submit a new Form W-4 to your employer with the updated information. This can help you get closer to breaking even at tax time—meaning more money in your monthly budget now.
2. Track Life Changes That Affect Taxes
Marriage, divorce, having a child, buying a home, or changing jobs can all impact your tax situation. If you’ve experienced a major life event, update your W-4 accordingly. These changes often affect the number of allowances or dependents you claim, which directly impacts your withholding. Staying current with your filing status helps you avoid being over-withheld.
3. Use Extra Income Wisely—Not as Extra Tax
If you earn freelance income, side gig money, or bonuses, make sure you’re accounting for it properly. Many people over-withhold during the year to cover tax they’ll owe on this extra income, but it may be more efficient to make estimated quarterly payments or adjust withholding incrementally instead. That way, you won’t be giving the IRS too much and waiting for a refund later.
Good Uses for Your Refund
If you are expecting a big refund, before heading to the mall or booking your next vacation, think about these options, in order of importance, to put your money to good use.
- Pay down high-rate debt. If you are carrying a balance with high-interest rates on credit cards or loans, it’s a good idea to use the refund to pay down the debt. We know this isn’t the most exciting way to use your return but it can save you hundreds of dollars in interest.
- Invest in your future. Put your tax refund into a retirement savings account such as an IRA or 401(k). This can give a nice boost to your earnings and overall returns.
- Cushion your emergency fund. If you don’t have at least 3-6 months’ worth of salary saved, you may want to put your refund into your emergency savings fund.
- Pay for a need. Maybe you’ve been putting off buying a new refrigerator, making a needed home repair, or getting new tires for your car. These are excellent examples of “needs” that can be covered fully or in part with your tax refund.
- Have some fun. The recommendations above should take priority but it’s also important to do a little something for yourself. A good rule of thumb is to spend about 10% of your tax refund on something that you enjoy. Maybe that’s eating out at your favorite restaurant, getting a new outfit, or booking a pedicure.
Deciding what to do with your refund depends on your financial situation and your future goals. If you have questions, Members Trust is ready to help. Contact us for answers.
*https://www.cbsnews.com/news/tax-refund-size-by-state-wyoming-connecticut-new-york/