Teens and Their Money: Financial Literacy for the Younger Set
Rethinking the Tax Refund
Everybody loves a tax refund. But as good as it can feel to get a fat check from Uncle Sam, the best strategy for maximizing your dollars in many cases is to minimize your tax refund, according to personal finance experts.
A tax refund typically means you have been paying more than the appropriate amount of income tax to the U.S. government over the course of the year, providing Uncle Sam with what amounts to an interest-free loan directly from your paycheck in the form of withholding. The tax refund essentially is the government repaying you for the loan. Trouble is, not only can’t you charge Uncle Sam interest for the right to borrow money from you, you’re losing the opportunity to put that money to constructive use yourself.
“Those funds could be put to much better use,” said Ray Benton, CFP®, with Lincoln Financial Group in Denver, Colo.
You could, for example, put that money:
• into an investment or retirement account, where it has a chance to grow. One especially wise move is to put the money into a tax-deferred “qualified” retirement account, like a 401(k), where not only does it have a chance to grow over the long term, it also reduces your taxable income for that tax year, likely cutting the amount of tax you owe. Benton calls this a tax “double-whammy” — and a good one. It turns into a triple-whammy if the extra contribution into the retirement account comes with a matching contribution from the employer, he notes.
• toward paying down credit card debt or a mortgage.
• toward a larger down-payment on a car or a home than you’d otherwise be able to make, thus reducing your debt going forward.
• toward a child’s college education.
• into an emergency savings account.
• toward a vacation or some other worthy goal for which you’ve been saving.
A tax refund of a few hundred dollars may not warrant taking action. But when the refund reaches into the thousands of dollars, said Benton, it’s probably time to adjust your tax withholding, which entails submitting an IRS form called a W-4 that instructs the government as to the amount of income tax to withhold from each paycheck, based primarily on your tax filing status (single or married), your projected income and the number of withholding allowances you claim. You can file a W-4 through your employer’s payroll or human resources department, or you can direct your tax preparer to do it for you.
Examples of life events that warrant withholding review for changes include marital status changes: marriage / divorce / death of a spouse; dependents: additions to the family through birth or adoption; and purchase of a home may now allow for itemizing deductions due to mortgage interest and taxes.
Either way, before you take action it’s best to consult a professional, such as an accountant or CFP® professional, to help you determine an appropriate withholding level. A CFP® professional also can help you decide how to best use the money that will no longer be withheld from your paycheck. To find one in your area, check out the Financial Planning Association’s national planner database at .
One way to determine what your withholding amount should be, and whether you’re on track to withhold more than you should, is with the IRS Withholding Calculator at Individuals/IRS-Withholding-Calculator.
It’s a quick and worthwhile number-crunching exercise, especially given the potential benefits you’re in position to reap by putting your hard-earned dollars to better use, as generous as your gesture of providing Uncle Sam with an interest-free loan might seem, and as good as it might feel to get that sizable refund check as payback.
BOILERPLATE
May 2014 — This column is provided by the Financial Planning Association® (FPA®) of Minnesota, the leadership and advocacy organization connecting those who provide, support and benefit from professional financial planning. FPA is the community that fosters the value of financial planning and advances the financial planning profession and its members demonstrate and support a professional commitment to education and a client-centered financial planning process. Please credit FPA of Minnesota if you use this column in whole or in part.
The Financial Planning Association is the owner of trademark, service mark and collective membership mark rights in: FPA, FPA/Logo and FINANCIAL PLANNING ASSOCIATION. The marks may not be used without written permission from the Financial Planning Association.
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