Every year, taxpayers fall into one of two categories: the owe category or the refund category, and there are reasons you may end up owing one year and getting a refund the next. Either way, now is the time to start getting ready for the 2025 tax season to hopefully get out of the owe category and back into the refund column.
The tax man cometh: Now what?
If you ended up owing Uncle Sam this year for 2023’s taxes, don’t fret. There may be some simple steps you can take to change your fortunes going forward. The first is simple: Review what changed over the previous year. Did you get a new job? What about a promotion? I am sure that felt amazing. But that new corner office could be costing you.
The most common problem I encounter with my clients who are still in the workforce is improper withholdings on their W-4 form. This usually happens when someone switches employers or gets a hard-earned promotion that puts some of their income into a higher marginal tax rate. If this is the case, I recommend you update your withholdings right away on your W-4 with your employer to avoid a surprise tax burden down the road.
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If you are retired and owed federal income tax this year for 2023, I would review your withholding amounts on all retirement income sources. Usually, I find an income source with no federal withholding or not enough withholding. The same advice applies here as with your W-4. Update that as soon as you can to help decrease the likelihood of a federal tax bill. If your monthly retirement income sources have the proper withholding, did you take any one-time IRA withdrawals? If you did, there was likely an improper amount withheld for federal tax.
Looking at your withholdings if you’re still in the workforce or retired might get you moving in the right direction, but it doesn’t guarantee a refund. If you’re still in the workforce, consider increasing the amount you are saving in a pre-tax retirement plan or a health savings account (HSA) at work.
For those of you who received federal tax refunds this year for 2023, congratulations! Hopefully, you’ll get another one next year. If you do, you’ll have three choices in front of you: Spend it, save it or invest it.
Spend your refund
Advertisements will likely tell you to spend your refund on everything from a new TV to a down payment on a car to a fun vacation. Doing this might make sense for you. Especially if you need to replace certain items. But there are other ways you can “spend” your refund.
Your federal tax refund can also pay off one of your high-interest credit cards, your student loans or your car loan. By paying off debts, you will free up that minimum monthly payment amount to allocate to something else. That could be hundreds of dollars now available in your monthly budget!
If you’re one of the fortunate few with no debt, then what should you “spend” your refund on? You could gift it to a friend or family member, maybe donate to a cause you’re passionate about or spend it on yourself to further your education — leading to raises in your working income or expanded horizons.
Save your refund
I recommend having three to six months’ worth of your monthly expenses in a savings account. So, if you don’t need to spend your return, you can use it to build or rebuild your emergency fund. This way you’ll be able to access your cash quickly to help pay for things when life happens.
If you have all your extra cash in investments and need to take a withdrawal when the market is down, you are forced to sell investments that have depreciated in value. If you have your emergency fund in a savings account, then the market shouldn’t have an impact. If you use your emergency fund to cover your expense AND you have an investment account, you can always sell off investments when the market is up to replenish the cash in your savings account. These options may help you handle emergencies that life may throw at you.
Invest your refund
The last path is to invest. I have clients in the workforce who use their federal tax refunds for Roth IRA or traditional IRA contributions. Non-retirement investments are available at any age, and it doesn’t matter if you are working or retired. There are a lot of options available, but the most common ones I see are mutual funds, annuities and certificates of deposit (CDs). I work with individuals who also use their refund to add to a 529 plan that can be used for future education expenses. Sometimes these 529 contributions can give you a state income tax deduction, depending on the 529 plan and where you live. I would recommend working with your financial professional who can help illustrate the pros and cons of each investment to help you make an informed decision.
Finally, I would encourage you to try to get your federal refund amount as close to $0 as possible. I’ve heard of some large federal refund stories, but it would be better to have access to that money throughout the year. I suggest teaming up with a tax preparer who can assist with getting your federal tax withholding just right and be a trusted point of contact when your financial picture changes.
If you spend your refund, spend it wisely, and if you save it, make sure you are getting a good interest rate. If you choose to invest, team up with a financial professional who is passionate about financial education and will lead you to an informed decision.
This material was created for educational and informational purposes only and is not intended as tax or investment advice. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to effect some of the strategies. Investing involves risks including possible loss of principal
The views expressed here are those of the author(s) and do not necessarily represent the views of TruStage. Securities distributed by CUNA Brokerage Services, Inc. (CBSI), Member FINRA/SIPC, a registered broker/dealer, 2000 Heritage Way, Waverly, Iowa 50677, toll-free 866.512.6109. CBSI is a limited business broker/dealer (Member FINRA/SIPC), a fully owned subsidiary of TruStage Financial Group, Inc. Non-deposit investment and insurance products are not federally insured, involve investment risk, may lose value, and are not obligations of or guaranteed by the financial institution. Representatives offer retirement and investment education but do not provide investment, legal or tax advice. Participants are encouraged to consult their financial professional. CORP, TRS-6866200.1-0824-0926 611214-01-02
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