Truthfully, I don't really want to think about it too deeply. But if your tax refund is consistently over $1,000, there's probably room for adjustment.
We've had some hefty refunds over the past few years—seriously big ones. While logically I know that a large refund isn’t ideal because it essentially means you're giving the government an interest-free loan, it’s hard not to enjoy the windfall. Still, this year, after receiving another substantial return, we decided to take action. Surprisingly, it wasn’t complicated at all.
I don’t fully grasp the concept of withholding allowances, but the general idea is straightforward: the more allowances you claim, the less tax gets deducted from each paycheck. My husband and I had always assumed he should claim two allowances—one for me and one for our child. Turns out that wasn’t accurate. The IRS offers a handy calculator on their site specifically for this purpose. You can find it here. Be sure to have a recent pay stub and last year’s tax return handy to help guide you. When we ran the numbers, we discovered my husband should have been claiming six allowances instead of two. No wonder we were getting such massive returns!
Taxes are confusing, and adjusting allowances can feel intimidating. What if you mess it up and end up owing money—or worse, create a financial mess? Using the IRS Withholding Calculator with reasonable estimates should help minimize risks (I think I ran the calculator about 14 times with different scenarios to ensure accuracy!). A key point to remember: this calculator provides guidance for the remainder of the current tax year. Since it accounts for taxes already paid, you'll need to revisit your allowances for the following year. I’ve already added a reminder to my calendar for early next year.
Once we determined the correct number of allowances, my husband simply logged into his payroll system and updated his W-4 form. If your employer doesn’t offer an online option, you’ll need to submit a new W-4 form in person at your workplace.
For us, this change translates to a boost in our monthly income. However, we’re committed to channeling this extra money into savings, as our tax refund usually goes toward our savings goals. Given our track record of disciplined budgeting, I believe we can stay on track. But if we weren’t great savers, keeping the large refund might have been a smarter move—it’s essentially an automatic savings plan.
Consider this example: If your typical tax refund is around $4,000, that equates to roughly $333.33 extra per month. If you invested that amount into a mutual fund averaging 8% annually, assuming quarterly compounding (which isn’t exactly how mutual funds work but gives a rough estimate), you’d end up with $4,121.57 by year-end. That’s $121.57 earned without lifting a finger! If you don’t adjust your withholding, the government keeps that $121.57. Sure, it benefits them, but why miss out on extra cash for yourself when the process is relatively simple?
I’m genuinely excited to see how much we can grow our savings this year!
How do you typically use your tax refund? Or what would you do differently if you adjusted your withholding allowances?
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