Tax season often sparks conversations about refunds—whether it’s bragging rights over who got the biggest one or complaints about having to pay the IRS. But what if there’s a “perfect” tax refund amount? Is there an ideal figure you should aim for when it comes to getting money back from the government? Let’s dive into why finding the right balance matters and how you can set yourself up for financial success year-round.
Why Do People Receive Tax Refunds?
A tax refund happens when you’ve paid more taxes throughout the year than you actually owe. This can happen for several reasons:
- Over-withholding from Paychecks: Employers calculate how much tax to take out of your paycheck based on your W-4 form. If you don’t adjust it properly, you might end up with too much withheld.
- Tax Credits and Deductions: Refundable credits, like the Earned Income Tax Credit (EITC), or nonrefundable credits and deductions can possibly significantly reduce your tax liability, resulting in a refund if your payments exceed what you owe.
- Overpayment of Quarterly Taxes: For freelancers, contractors, or business owners, estimating quarterly tax payments can be tricky. Overestimating often leads to a refund.
The Psychology of a Tax Refund
Tax refunds can feel good. Getting a lump sum can be exciting and satisfying—like a financial pat on the back. It’s no wonder many people intentionally aim for a big refund, seeing it as forced savings. But is this strategy truly beneficial?
The Case for a Smaller Refund
While a big refund might feel rewarding, it’s not always the smartest financial move. Here’s why:
- Your Money, Your Terms: A refund essentially means you’ve given the government an interest-free loan. That money could have been earning interest in a savings account or growing in an investment portfolio throughout the year.
- Cash Flow Flexibility: A smaller refund means more money in your paycheck throughout the year. With better cash flow, you can pay down high-interest debt, contribute to retirement accounts, or handle unexpected expenses possibly with relying less on credit.
- Avoiding Missed Opportunities: Money in your hands today might be more valuable than the same amount a year later. You can put those funds to work sooner.
The Risks of a Large Refund
Beyond opportunity costs, a large refund can also lead to:
- Misaligned Financial Goals: Many people often treat refunds as “bonus money” and spend them impulsively rather than using them for important goals like saving, investing, or paying off debt.
- Poor Budgeting Habits: A reliance on refunds can create a false sense of security. Instead of building solid budgeting habits, you might overspend during the year, assuming your refund will bail you out.
- Unnecessary Delays in Accessing Money: Waiting for a refund might cause you to postpone critical expenses or investments, especially if you’re banking on the IRS to send your money back.
When a Refund Makes Sense
That said, there are situations where a refund can be beneficial:
- Forced Savings for Big Goals: If you struggle to save consistently, a refund can act as a lump sum to fund major purchases, emergencies, or investments.
- Peace of Mind: Some people prefer the reassurance of knowing they’ll get money back rather than worrying about owing taxes when filing.
- Eligibility for Tax Credits: If refundable credits make up the bulk of your refund, it’s less about over-withholding and more about maximizing benefits you’re entitled to.
The Optimal Tax Refund: $0
The “perfect” refund amount is technically $0. Why? Because it means you’ve accurately estimated your tax liability and avoided overpaying or underpaying throughout the year. Working toward this balance lets you keep more of your money in your pocket while avoiding any surprises come tax time.
How to Aim for a Balanced Tax Bill
If breaking even sounds appealing, here are steps to help make it happen:
- Review Your W-4 Form: Update your W-4 with your employer to reflect your current financial situation. Use the IRS Tax Withholding Estimator to calculate the correct amount of withholding.
- Track Life Changes: Marriage, divorce, having a child, or buying a home can significantly affect your tax situation. Update your W-4 accordingly.
- Estimate Quarterly Taxes Accurately: For self-employed individuals, track your income closely and use tools or professional advice to make precise quarterly payments.
- Plan for Credits and Deductions: Understand the tax credits and deductions you qualify for and factor them into your withholding or payments.
- Work with a Tax Professional: Want to make sure you’re not overpaying or underpaying taxes? Gertsema Wealth Advisors can help! Let’s chat about how to fine-tune your strategy and set you up for financial success.
What to Do with Extra Money
If you’ve adjusted your withholding and now have more money in your paycheck, use it wisely. Consider these options:
- Pay Down Debt: Eliminate high-interest debt, like credit cards or personal loans.
- Boost Savings: Contribute to an emergency fund, ideally enough to cover 3–6 months of living expenses.
- Invest: Maximize contributions to retirement accounts, such as a 401(k) or IRA. You can also explore other investment opportunities.
- Plan for Big Goals: Save for major expenses like a down payment on a house, a new car, or a family vacation.
The optimal tax refund amount depends on your financial goals, habits, and mindset. While some prefer the psychological boost of a refund, the most financially efficient approach is to aim for $0—keeping your money in your hands and working for you year-round. By understanding your tax situation and making adjustments, it could help you strike the perfect balance between tax liability and take-home pay, setting yourself up for financial success.
Ready to take control of your tax strategy and optimize your financial planning? Gertsema Wealth Advisors is here to help. Whether you want to fine-tune your withholding, plan for major life changes, or make the most of your tax situation, we’ll work with you to work toward your goals. Let’s chat and create a personalized plan that sets you up for success year-round.
