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Should You Take Your Tax Refund or Roll It Forward?

Assess your unique personal situations in order to answer this question.

By Ken Rosenbaum, CPA

Think forward to April 18th. 

Imagine you’ve just finished your taxes and learned that you’re going to receive a refund. What’s your initial reaction? Are you thrilled that you’re about to get “free” money? Is it already burning a hole in your pocket as you decide what you’re going to buy with it? Others may view their refund as forced savings.

As a Wealth Advisor with Buckingham Strategic Wealth, Ken Rosenbaum, CPA, RLP®, helps families chart their ideal path for the future and then works with them to achieve it through a values-based, holistic financial life plan that incorporates investment, tax, charitable giving, wealth transfer and retirement strategies.

Ken Rosenbaum

There are many ways to put your refund to good use if you’re more in this camp. You could put the money into a high-yield savings account, invest it in an IRA or Roth IRA to meet your income needs in retirement, or invest it in a 529 plan for you children’s education. If you have credit card debt and are paying a high interest rate on it, then using your refund to pay that down is probably a good strategy. 

A third group of people see that refund amount and get irritated about it. Irritated? Really? That type of reaction may seem counterintuitive – until you look more closely at why you received a refund in the first place. Then it may not strike you as good a thing as perhaps you initially thought.

Paying Income Taxes - The Basics

Stepping back to cover some basics, you know that every pay period your company sends a portion of your income to the government for taxes – your withholdings. At the end of the tax year (by the following April, when you file your taxes), it comes time to true-up, or calculate, the exact amount of taxes you owe based upon the exact amount of income you earned (including income from other sources) minus any deductions and/or credits for which you qualify.

If the amount withheld from your paychecks is more than what you should have paid, then you will receive a refund. So, essentially, you overpaid the government and are simply receiving back the amount of your overpayment. And while the government is “holding” your money, it is not paying you any interest. How kind of you to give the government an interest-free loan. Do you still feel as thrilled about that refund?

If you begin to feel less generous, that’s perfectly normal. The good news is that you have some control over how much your company withholds for taxes from your paycheck. There is a form called the W-4 (ask your human resources department where you can find it) that asks a few simple questions to help you decide how much to withhold. Basically, the more exemptions you request, or qualify for, the less money your company withholds for taxes throughout the year and the more money you will see in your paycheck.

Another common method for people to pay taxes throughout the year is via quarterly estimated tax payments. Here you make payments on a quarterly schedule based upon an estimate made at the beginning of the year. The good news for these taxpayers is that it can be easier to manage the amount you pay in and adjust it as the year winds on.

Whichever method you use to pay taxes, once you recognize that you have overpaid, the question then becomes what you should do with that refund. We’ve already talked about some choices, but one additional – and often under-mentioned – option is to roll your refund into the following year’s tax payments. This may sound like an attractive route, if not the most glamorous.

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Alternative Methods for Paying Income Taxes

But before simply defaulting to a “yes,” take a moment to ask yourself if you anticipate any significant changes over the coming months. Do you expect to show less income this year? Was last year an incredibly profitable year? Do you expect to recognize fewer capital gains this year? Are you planning for larger expenses this coming year? Are any health-care expenses or capital expenditures within your business deductible? Perhaps you are finally ready to glide into retirement or plan to fully retire at some point in 2022. If so, then you may not have as much income this year, and therefore would not need to pay as much on a quarterly basis.

After reassessing your personal situation in light of these and other factors, and if your refund ends up being about what you would expect to pay as your new first quarter estimate, then it seems logical to roll it into the next payment. However, if the refund is more than one quarter’s adjusted estimated quarterly payment, it may not make as much sense to roll it over. (This goes back to why would you want to give a tax-free loan to the government if you don’t have to.) In that case, consider receiving the amount of the refund above your first quarterly payment and then pay in your taxes throughout the rest of the year as needed.

Whether a refund is a good or bad thing is not so clear-cut. From an economic perspective, the most efficient use of your capital would be to have a $1 tax bill at the end of the year. However, for people who, for one reason or another need a little help saving, receiving a refund may work out for the best as long as it’s put to “good” use (invested for the long-term or used to pay down high-interest-rate debt, for example). In financial planning there are many instances where what is best economically does not fully align with what is best behaviorally.

As you dig in to determine what may be different this year from last year, you’ll start to see that the withholding process begins to become less about taxes and more about personal experiences and decisions. The right answer for you lies more in what personal situations you anticipate and the financial implications of your decisions. And doesn’t this seem like a more logical way to look at your entire financial plan anyway? Flip the process around and take the approach that money is a tool that you apply in pursuit of your best life.

About the author: Ken Rosenbaum, CPA, RLP®

As a Wealth Advisor with Buckingham Strategic Wealth, Ken Rosenbaum, CPA, RLP®, helps families chart their ideal path for the future and then works with them to achieve it through a values-based, holistic financial life plan that incorporates investment, tax, charitable giving, wealth transfer and retirement strategies.

Important Disclosure: The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth®. This article is for general information and educational purposes only and is not intended to serve as specific financial, accounting, legal, or tax advice. Individuals should speak with qualified professionals based upon their individual circumstances. The analysis contained in this article may be based upon third-party information and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, confirmed the accuracy or determined the adequacy of this article. R-22-3331

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