The average tax refund in 2018 was $2,881. If you're getting that much back every year, then you may be overwithholding, meaning you’re giving the federal government an interest-free loan for the year. If you owe the Internal Revenue Service (IRS) money at tax time, then you’re underwithholding. So how do you figure out the right W-4 form withholding code to use so you don’t have too much or too little withheld?
Withholdings
If you're getting money back, ask yourself two questions:
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Do you have credit card bills?
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Do you have an emergency fund to rely on for a few months if you become unemployed?
If you answered "yes" to the first question and "no" to the second one, getting a tax refund is not such a good deal. The refund is money you could have used all last year to pay off bills and to beef up your emergency fund. The good news about your refund is that you can use it right now to address those issues. So, tempting as it is to treat yourself when that check comes in from the IRS, use it to relieve some financial stress instead.
To break even, look at last year's tax bill. If the amount you had withheld was close and you haven't had major lifestyle changes, such as getting married or having a baby, then you're probably safe to leave your payroll withholding the same. If you owed a lot or received a large refund, then you might want to adjust your withholding.
Adjusting your W-4
The more allowances you claim on your W-4 form, the less income tax will be withheld. The fewer allowances you claim, the more income tax will be withheld.
If you're getting a large refund, visit your employer's payroll or human resources department and change your W-4 form, which establishes how much your employer withholds for taxes each paycheck. Use this withholding estimator to see how adjusting your withholding affects your take-home pay. You’ll need to refer to your last paycheck or paystub to answer all the questions. By increasing your allowances, you could see a few hundred dollars more each month in your paycheck.
Now it won't help much if that extra money just slips through your fingers. So, take one more step, and set up direct deposit of that newfound cash to your credit union emergency fund account, every payday. Trust us: Having a full rainy-day fund feels a lot better than a once-a-year tax refund!