From an economic perspective, it makes sense to only withhold what is necessary to cover your tax obligations. This assumes that a taxpayer has the discipline to save the extra money instead. Unfortunately, from a practical perspective this does not happen nearly enough. I suggest changing your withholdings to what you think your taxes will be and have the difference sent to your savings or money market account directly via payroll deduction, if possible. You earn interest on the extra money and force the savings to really happen.

A taxpayer should most definitely try to break even at tax time. Unfortunately, many people use their withholding as a forced savings plan because they believe that they are not disciplined enough to save on their own. In reality they are giving the government an interest-free loan every year. There are much better ways to create “forced savings” that are simple and can be set up to occur automatically. Two of the easiest venues available are: 1). Your company’s 401(k) plan. The money is invested and begins working for you immediately, and with significant tax benefits, or 2). An automatic investment plan with a mutual fund company or managed account program where you have a defined amount of money withdrawn from your checking account monthly and deposited into your investment account. In either case, you never actually have the money in your hands, but it is invested and working for you, potentially earning interest/growing in value. Certainly a far better scenario than lending the government money in the form of a nocost loan. If you are receiving a large refund it would definitely be prudent to change your withholding. Consult your financial or tax adviser to make certain that you have the correct amount of taxes withheld.

Getting a tax refund always feels good. In reality, however, you have made the government an interestfree loan, which isn’t good. It should be every taxpayer’s goal to owe as much as possible on April 15th of each year without paying any underpayment penalties. Keep your money earning interest as long as you can and pay the IRS only when the funds are due. There are safe-harbor tests for the amount of tax that you must pay in each year to not be penalized. It is good practice to pay only that amount and leave the rest of your tax liability invested in safe shortterm investments such as money market funds or certificate of deposits. So to answer your question, if you are getting a significant refund each year, increase your exemptions and take less tax out of your paycheck. Make sure that nothing else has changed that will change your tax liability. If you can, put the increase that you will see into your retirement account. This will put you in even better shape for retirement!

What do you do with the refund check? Do you spend it to pay down debt or do you save it? If you need it to pay off a credit card, by all means, do so. However, if you really want to “save” the money, then adjust your withholdings and immediately increase your monthly 401(k) deferral amount, so the money goes directly into your retirement plan. The money is still out of sight, but now it is being put to work in a more timely fashion.