Getting a $1,000 tax refund can feel like a small win. However, that refund may not be the bonus you think it is. In reality, it can be a sign that too much money was taken out of your paycheck throughout the year.
In some cases, a larger refund could be the result of changes in tax law, new credits or shifts in income. But for most people, it happens because more federal income tax was withheld from their paycheck than they actually owed.
Having more money than necessary withheld from your paycheck probably isn’t ideal, as you could have used that cash throughout the year. Moreover, when too much tax is withheld, you’re essentially giving the government interest-free access to your money.
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Over-Withholding Is More Common Than You Think
You’re not alone if this happens to you, as millions of Americans also over-withhold each year. IRS data shows that the average tax refund is around $3,000, which suggests many households are effectively giving the government interest-free loans.
Sure, a $1,000 refund may not seem alarming compared with that average. But it still works out to about $83 per month — money that could have been in your pocket all year.
Why Over-Withholding Can Be a Financial Problem
When too much tax is withheld, your budget could be thrown off kilter. For instance, you feel like you’ve been overspending or falling behind, when in reality your take-home pay is lower than it needs to be.
Sure, you could think of a tax refund as a “forced savings” of sorts. But that logic breaks down if you are using the refund to catch up on bills, pay late fees or cover expenses that created stress all year. Money that’s withheld can’t be used to help you handle real-time needs such as emergencies.
Even if you have savings, a large or unexpected expense — a car repair, medical bill or even a rent increase — could mean you’re left scrambling while you wait for tax season to roll around.
Why So Many People End Up Over-Withholding
Most people don’t intentionally over-withhold. It often happens when someone forgets to update their W-4 after a raise or other life change, such as getting married, divorced or having a spouse return to work.
For some, over-withholding may be a deliberate choice driven by fear of owing money at tax time. While that fear is understandable, it can come at the cost of year-round financial flexibility.
How $83 a Month Could Actually Help
There are so many uses for $83 a month, but here are a few ways it could make a meaningful difference:
- Adding to your emergency fund
- Paying off high-interest debt, such as credit cards
- Cover rising everyday costs like groceries or utility bills
- Increasing contributions to a retirement account
Take a closer look at what you could really do with the money. Adjusting withholding can be especially impactful if the extra cash helps you stay ahead of expenses or reach long-term financial goals.
How To Adjust Withholding
To change your withholding, fill out a new Form W-4 and submit it to your employer. This form lets payroll know how much federal income tax to withhold from your paycheck, and you can update it at any time.
If you’re unsure how to adjust it, you can head to the IRS’ tax withholding calculator. The tool walks you through your income, credits and deductions, then provides guidance on how to complete a new W-4 so your withholding more closely matches what you actually owe.
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This article originally appeared on GOBankingRates.com: How a $1,000 Tax Refund Can Actually Signal a Financial Problem
