TL;DR: Is a Massive Tax Refund Actually a Good Thing?
Tax season brings up the same age-old question: Is it better to get a massive refund or break even? While nobody likes to owe the IRS, getting a huge check isn’t always the financial win it feels like.
Here is the TL;DR on managing your tax withholdings, straight from the team at Buffalo First Wealth Management.
The Big Refund: Pros and Cons
In a perfect world, you want to break even. When you get a massive refund, you are essentially giving the government an interest-free loan all year. That money could have been in your paycheck, actively paying down debt or earning interest in a savings account.
The Exception: If you struggle to save money, a big refund acts as forced savings. It gives you a lump sum to kickstart an emergency fund or wipe out a credit card balance. If this is the only way you can get yourself to save, a larger refund might actually make sense for your financial habits.
The Danger of Owing Money
On the flip side, owing the government is painful—especially because underpaying throughout the year can trigger unexpected penalties. Check the bottom of your Form 1040; you do not want to owe the IRS a penalty fee on top of your tax bill.
The Goal: Aim to break even. If you owe or receive about $1,000, you are in the sweet spot. If your number is significantly higher in either direction, it is time to make some adjustments.
How to Fix Your Withholding
If you are a W-2 employee, adjusting your tax balance comes down to updating your W-4 form through your payroll department.
When to Update Your W-4
You should submit a new W-4 whenever you experience a major life event, including:
- Getting married or divorced.
- Having a baby.
- When your children are no longer claimed as dependents.
W-4 Pro-Tips to Keep in Mind
- Coordinate with your spouse: If both you and your spouse work, coordinate your W-4s so one person doesn’t under-withhold while the other over-withholds.
- Account for gig work: Your primary employer doesn’t know about your side hustle. If you have 1099 income, your W-2 job is under-withholding. Remember, you also owe an extra 7.5% in taxes for the employer half of Social Security and Medicare on gig income.
- Add extra withholding: If you consistently owe money, you can specify an extra dollar amount (like $50) to be withheld from each paycheck directly on the last page of your W-4.
Don’t Just File and Forget
By the time you file, you are probably exhausted by the mere thought of taxes. However, right now is the best time to review your return. Look at how your numbers were generated, factor in deductions like the child tax credit, and update your W-4 while you still have the rest of the year to balance things out.
Stay tuned for our next post.
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