Should You Receive a Tax Refund?

Addison Adelberg, CFP®, FPQP™

May 13, 2024

Every spring, a buzz about tax refunds fills the air. It’s no surprise; the idea of receiving money back from the government tends to spark excitement. When I join client meetings, the tax refund conversation often revolves around two main themes: how clients plan to spend their refunds or how they want to make the most of it.

Since TCI sees investing through a long-term lens, let’s focus on the latter. Rather than figuring out ways to optimize your refund, let’s dive deeper and explore the nuances of tax refunds, their implications on your long-term goals, and how they factor into your broader financial journey.

What Should the Ideal Outcome Be When Filing Your Tax Return?

At TCI, taxes are a primary consideration at every turn of your financial journey. We consider each decision with an eye toward immediate tax implications and their ripple effects in the years ahead.

One of the goals for everyone on your TCI team is to position you for tax success. At TCI, tax success means minimizing your tax burden, paying what you owe without overpaying or incurring penalties. Receiving a tax refund indicates that you’ve overpaid your taxes. Essentially, you have given the government an interest-free loan.

Rather than lending money to the government, TCI strives to help you optimize your cash flow and investments, ensuring that every dollar helps you achieve your long-term financial goals. That means more money working for you in the market or earning you a steady rate in a high yield savings account or money market fund.

What does it look like if that money was invested instead of lending it to the government?

An Opportunity to Save More

Instead of overpaying and anticipating a $5,000 tax refund, you decide to invest the same amount into a money market account. At current interest rates, these accounts yield between 4.5% and 5%. Over the course of a year, your $5,000 could have generated around $250 in interest income. While this may not seem substantial at first glance, let’s examine some key factors that influence our success as investors:

  • How much are you saving?
  • How long do you plan to save?

Initially, $250 may seem like a small amount, but consider its potential growth in the market through compounding. With each passing year, it becomes increasingly significant in achieving your financial goals.

How to Adjust Your Withholdings

Your TCI team is here to support and guide you through all financial decision making, including optimizing your tax withholdings. If you’re consistently receiving tax refunds, it could signal an opportunity for adjustment.

If You’re Still Working

Your withholdings are determined by your W-4 tax form, which is called an Employee’s Withholding Certificate. Your employer uses this form to determine how much tax should be withheld from your paycheck each pay period, based on factors like your filing status (married or single) and your dependents (minor children). The IRS recommends filling out a new W-4 form yearly or anytime your financial circumstances change. If you are a higher income earner or have additional sources of income, you may need to withhold additional amounts. During your next meeting, your TCI team can review your W-4 and help you make any necessary adjustments.

If You’re Retired

Similar to your working years, as a retiree you’ll need to account for all sources of income for tax purposes: capital gains, social security, pension plans, retirement account distributions, etc.

Your retirement accounts will allow for tax to be withheld each time you take a distribution. Your TCI team can help set up and adjust those withholdings dynamically as your tax situation changes from year to year. We can work with your CPA or tax preparer to make sure the withholdings are correct. We’ll try and make sure that you pay the least amount possible, without incurring penalties or interest from the IRS.

Did You Owe Taxes in 2023?

Let’s say that you had the opposite occur in 2023: You didn’t withhold enough taxes throughout the year, and you received an unexpected tax bill in April.

The course of action is similar for those under withholding as those who overpay. We would reevaluate your situation and help you adjust your W-4 withholdings and the withholdings on whichever retirement income sources are relevant to your unique situation.

There’s no penalty for overpaying on your taxes, nor is there an incentive to do so. However, you could be subject to penalties from the IRS if you come up short each year. There are two exceptions to this rule:1

  • You’ve paid at least 90% of the tax you owe in the current year.
  • You’ve paid 100% of last year’s tax return (110% if you’re a joint filer with an adjusted gross income of $150,000 or more).

How to Avoid Underpayment Penalties

In addition to adjusting your withholdings, certain circumstances may require making estimated or quarterly tax payments, to make sure you’re sufficiently planning for your expected tax liabilities. By staying informed about your tax obligations and making timely payments as necessary, you can avoid penalties and maintain financial stability throughout the year.

Roughly, here’s when quarterly tax payments are due each year:

  • April 15: For income earned between January 1-March 31.
  • June 15: For income earned between April 1-May 31.
  • September 15: For income earned between June 1-August 31.
  • January 15: For income earned between September 1-December 31 (of the previous year).

Your TCI Advisor can work with your CPA to determine if estimated tax payments are necessary and how much you can expect to pay.

Let’s Optimize Your Taxes in 2024 and Beyond

Tax planning is a multifaceted process but with prior planning, your TCI team can work to ensure that your tax obligation is as close to “just right” as it can be every year.

If your 2023 tax return is completed and filed away, let us make a copy of it at your next meeting or upload it to your client portal. Your TCI team can examine your refund or bill from last year and see how to bring it closer to zero this year. Remember, tax planning is not necessarily about the least amount of taxes in the current year. It’s about paying the least amount of taxes across your overall lifetime, and that is where we can help.

1. – Underpayment of Estimated Tax by Individuals Penalty 

TCI Wealth Advisors, Inc. is not a certified public accounting firm and no portion of the content should be construed as accounting advice.

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