Most people end up owing or receiving a refund at tax time. If you owe exactly zero, you probably don't need this article because you clearly know what you are doing. But for everyone else, the question is often how can you use your refund to improve your overall finances? And if you owe, how can you ensure that doesn't happen next year?
Disclaimer: I am not a tax professional. I am a blogger giving you something to think about at tax time. Consult your tax professional to fully understand the tax consequences for your specific situation before making any changes.
Tax Liability
Let's start with what to do if you owe. First, pay your taxes as soon as possible to avoid penalties and interest. If you can't afford the bill, work with the Internal Revenue Service to create a payment plan. This is also the moment where I reiterate the timeless advice to have a healthy emergency fund to handle any unexpected expenses. Being able to pay your tax bill immediately is the ideal scenario in this not-so-ideal situation.
Increase Your Withholding
The best way to make sure that you don't owe next year is to fill out a new W-4. The W-4 is the tax withholding form you fill out when you start a job. Are there other extenuating circumstances that can trigger an unexpected bill? Of course. But if that is your situation, then you are probably completely aware of why you owe this year.
For many people, owing on taxes may simply be the result of changing income, tax brackets, and life circumstances since the last time they filled out a W-4. Ensuring that you are withholding the right amount will solve this issue for many taxpayers.
If you haven't filled out a new one in a while, the W-4 has changed slightly. You can find the current form online by searching for W-4 and the year. Once you find it, double-check the year in the upper right corner of the form. Follow the instructions for filling out each part.
There is an online tax withholding estimator available to determine how much to withhold. If you are internet-averse, there is a funky table to help you estimate additional withholdings if you have two incomes. The online estimator will be most accurate, but the table can give you a rough idea of whether you are withholding enough each pay period.
Talk to your human resources or payroll department to find out how to change your withholding. Some companies may require you to fill out a new W-4 form. Other companies may have an online portal that allows you to change your withholding electronically.
Reduce Your Tax Liability
Another way to reduce your tax bill is to reduce your income. There are a few ways you can do this. The easiest way to reduce your taxable income is to increase your pre-tax contributions to a traditional retirement account.
You can also take a look at this list of tax deductions and tax breaks by Nerdwallet and see if there are any that apply to you. My personal favorite is my Health Savings Account (HSA). If you don't have one, I encourage you to consider one if your health plan qualifies.
You must have an HSA-eligible high-deductible health plan, which may not be the best fit for everyone's health situation. Just don't let the words "high deductible" keep you from considering it. While some plans have truly high deductibles (I am currently cringing at the thought of the $10,000/family high deductible plan I have through my employer) some qualifying plans have deductibles as low as $1600 for individuals and $3200 for families in 2024. A deductible is the amount you must pay out of pocket before insurance will cover costs.
When choosing a plan, pay attention to how much coinsurance you will still owe after meeting the deductible (usually listed as a percentage), as well as out-of-pocket maximums (usually listed as a dollar amount).
If this type of plan will work for you, then you can qualify for a Health Savings Account (HSA). The tax benefit to an HSA is that the money you or your employer puts in is pre-tax or tax-deductible. The contribution limits change each year. The limit for 2024 is $4,150 for individuals and $8,300 for families. If you are over 55, you can add an additional $1000.
You can invest the money in your HSA and the growth is tax-free. If you spend the money on health expenses, it is also tax-free. If you do not use the money, the balance rolls over each year. You can also take the account with you if you leave your company.
If you are so healthy that you can't come up with enough health expenses to spend this money on in your lifetime, you can use the money for non-health expenses after age 65, although you will owe taxes on any withdrawals.
It may not be for everyone, but I love the many benefits my HSA provides.
Tax Refunds
If you are celebrating because you have a refund instead of a tax bill, congratulations! There is something really satisfying about receiving a large deposit in your bank account, but in this case, that large deposit just means that you withheld more than necessary to meet your tax obligations.
If you have a huge return each year, you can consider reducing your withholding so you have a little more money each month to put into savings and earn interest throughout the year. However, if you feel that receiving a large refund helps you be more successful in saving money rather than spending it, then keep doing what you are doing.
Many people spend the extra money they receive and treat themselves to a special splurge or indulgence. Some years, this might be best for your mental health. However, there are other options that you may want to consider that will help strengthen your financial health.
Build Your Emergency Fund
You knew I was going to say it. If you don't have an emergency fund covering 3-6 months of expenses, you should consider putting at least some of your refund toward your emergency fund. The best spot for most emergency funds is an FDIC-insured high-yield savings account to earn interest without risking your money.
If you have any large expenses approaching, you can start to save for these as well. A home or car purchase, a home improvement project, or a vacation are large expenses that require some financial preparation.
Pay Off Debt
If you have any high-interest debt, paying more toward the principal will help you pay off the debt faster and pay less interest. Credit card balances, personal loans, or car loans are usually loans that you want to pay off quickly unless you have a low interest rate. Paying off loans with small balances can also help free up cash flow in your budget to attack larger balances or other financial goals.
Contribute To A Roth IRA
If you are under the income and contribution limits, consider putting some of your return into a Roth IRA. The money you put into this account is already taxed. The money grows tax-free, and any withdrawals after age 59 1/2 are tax-free. Having a mixture of pre-tax and post-tax retirement accounts is usually beneficial, especially because Roth IRAs don't have required minimum distributions (RMDs).
Invest in Yourself
You can use your tax refund to invest in your personal growth. Is there a certification or skill that would help you get a better job or a promotion? What skills are necessary to stay current in your field? Look into workshops or certifications that will help you grow professionally. Make sure you vet any programs or workshops carefully, especially if they are expensive. There are plenty of courses led by "experts" that are willing to take your money. Make sure the course, workshop, or certification will bring you value.
Taxes Aren't All Bad
When you are paying taxes, it is often difficult to remember that taxes do benefit you. So as you hit submit on your taxes, think of the libraries that have enriched your life, the highways, roads, and public transit that allow you to get to the places you want to go, the safety nets that you or your loved ones may rely on at some point in your life. Remember that educating the next generation (whether you have kids yourself or not) is probably good for society as a whole. You may not agree with how every dollar is used, but there is probably something funded by taxes that you like. Practice mindfulness and reflect on how those things make your life better. Appreciate that you had income. Pay your taxes, and make whatever changes are necessary to make it less painful next year. Bestie, you've got this!
Comments