The Truth About Tax Refunds

Do you get excited every year when you find out you’re getting a big tax refund? Well, we hate to be the bearer of bad news, but it’s not exciting at all once you hear the truth about why you’re getting a refund in the first place.

Contrary to popular belief, your tax refund isn’t free money—it’s your money. And it’s money that should’ve been in your pocket all along. Remember folks, Santa Claus does not live in Washington, D.C.!

Here’s the bottom line: When you get a tax refund, it just means you’ve been loaning the government money interest-free throughout the year—and they’re just returning that money to you.

On the flip side, you don’t want to put yourself in a position where you break into a nervous sweat finding out you owe hundreds (or even thousands) of dollars in taxes to the IRS. That sends shivers down our spines just thinking about it.

So, what’s the solution? How do you get to Tax Day without getting a big tax refund or a big tax bill? The answer is to get your tax withholding right so your tax bill is as close to zero as possible. Here’s how you do that.   

 

How to Get Your Tax Withholding Right

Your tax withholding is the amount of money your employer holds back from your paycheck to pay your fair share in taxes. You can work with your company’s HR department to make adjustments and make sure it’s more or less the right amount.

Step 1: Total up your tax withholding.

Let’s start by adding up your expected tax withholding for the year. You can find the amount of federal income tax withheld on your paycheck stub. Once you see how much money you have withheld from each paycheck, you can multiply that by how many paychecks you get each year to find how much tax you’re having withheld throughout the year.

Step 2: Estimate your tax liability.

Now that you know your projected withholding, the next step is to estimate how much you’ll owe in taxes for this year—that’s your tax liability. The IRS provides worksheets to walk you through the process, which is basically like completing a pretend tax return.

If you’re an independent contractor or freelance worker, listen up: Federal taxes are not automatically deducted from self-employment income. If you have a side business or do freelance work, you’ll need to do your own withholding. Set aside about a third of your freelance income to make sure you have the money to cover your freelance taxes at the end of the year.

Step 3: Subtract the difference.

Once you have an idea of how much you owe the IRS, it’s time to compare that amount to your total withholding. Take your annual tax withholding and subtract your estimated tax liability.

A positive balance means you’ll probably get a refund, while a negative balance means you owe more and you’ll have to pay the difference by the tax deadline.

Step 4: Adjust your withholding.

If you run the numbers and find you’ve got ground to make up, it’s best to adjust your tax withholding as quickly as you can. The longer you wait, the harder it’ll be to get it just right. You have two options:

  • File a new W-4 and submit it to your employer. If you’ve been at your job for a while and you’ve been getting big refunds or tax bills for years, filling out a new W-4 could help you get your tax withholding right.   
     
  • Specify additional withholding. You have the option on the W-4 form to enter an additional amount you want to have withheld for taxes from each paycheck. Simply divide your estimated tax shortage by the number of pay periods you have left before the end of the year to get your number. 

    For example, let's say you'll be short by $1,000 and you've got 10 pay periods left. Divide $1,000 by 10. You'll need to set aside $100 per paycheck until the end of the year.  
     

What to Do With a Tax Refund

Chances are, it’s too late to change things for this tax season. So, what do you do if you’re getting your money back with a tax refund? Here are some ways you can put those dollars to work for you: 

1. Pay off your debt faster.

If there’s one thing worse than paying taxes, it’s sending debt payments every month to some sleazy bank or lender. It’s time to break the cycle, people! You can use your tax refund to speed up your debt snowball and get out of debt faster.

And once you’ve adjusted your tax withholding, you can use that extra money from each paycheck to keep chopping away at your debt balance.

2. Beef up your emergency fund.

Don’t have any debt? Awesome! Then maybe you can use your tax refund to put some more distance between you and life.

We recommend having an emergency fund with 3–6 months of expenses saved up. When (not if) your car breaks down, your roof leaks, or you end up making a trip to the emergency room, you’ll be glad you have enough money in the bank to help you cover all of life’s emergencies.

3. Save up for a down payment or make an extra mortgage payment.

Buying a home is one of the most important (and probably one of the most expensive) purchases you’ll make in your entire life. You can use your tax refund to help you move one step closer to homeownership by adding it to your down payment fund.

Already own a home? Great! Using your tax refund to make an extra mortgage payment can help you pay off your home even faster.

4. Invest it for retirement.

The best time to start investing for retirement was yesterday. But the next best time is today—and your tax refund could give your retirement savings a much-needed boost. If you’re not maxing out your Roth IRA, think about investing your tax refund in good growth stock mutual funds inside your account. 

5. Enjoy some of it.

If you’re out of debt and have plenty of money sitting in the bank, it’s okay to treat yourself a little bit. It’s your money after all! Whether you want to use your refund to help pay for that family vacation you have coming up or to upgrade your wardrobe with some new clothes, just make sure you have a plan and don’t go overboard. 

File Your Taxes With Confidence in 2024

Don’t let taxes overwhelm you or your budget. You're smarter than that. Take the stress and confusion out of filing—and save big—with our Ramsey SmartTax software, the no-nonsense tax software you can trust. It’s simple with no hidden fees and no hidden agenda. It will even teach you and educate you along the way, so you feel empowered to do your own taxes with confidence.

File your taxes with Ramsey SmartTax!

But what if you have a more complicated tax situation or had a wild year in 2023? In that case, working with a tax pro is a smart move. And if you’re looking for a trustworthy tax professional who serves your area, try one of our RamseyTrusted tax pros. They know the tax code inside and out so you don’t have to.

Find a tax pro in your area today!