I'm getting my smallest tax refund ever this year and I couldn't be happier

Tanza Loudenback

Feb 17, 2020, 19:51 IST

I'm getting my smallest tax refund ever this year and I couldn't be happier

Giuseppe Lombardo/EyeEm/Getty

I didn't want a big tax refund this year (the author is not pictured).

Americans tend to fixate on refunds during tax season - the bigger, the better.
Often, people spend the money on big expenses like a vacation or paying off debt, or as an instant savings account.
If you're trying to build wealth, adjusting your tax withholdings can help reduce the size of your refund and increase your paycheck throughout the year to optimize every dollar you earn.
See Business Insider's picks for the best tax software »

Most Americans care about two things when it comes to taxes: owing less and getting a big refund.

In 2018, the Tax Cuts and Jobs Act reduced the average American's tax bill. But when filing season came around, many taxpayers weren't pleased to be getting lower-than-average refunds.

I understand the frustration. Between my state refund and federal refund, it's typical for me to receive well over $1,000 back from the government. For most people that feels like an extra pay day.

As turns out, the two aren't directly related. Employees who hadn't revisited their W-4 Form in 2018 to adjust their withholdings after the new law took effect were having less tax withheld, which resulted in more money in their pockets - and a smaller windfall during tax time.

"Many filers received a boost in their paychecks throughout 2018; that's where the remaining amount of their refund went," Mark Jaeger, the director of tax development at TaxAct, told me last year. "Instead of waiting to receive their money as a tax refund, they received it all year long."

Put another way, big tax refunds generally mean you paid more than you owed in taxes - you had too much income tax taken out of each paycheck, and now the IRS is returning what is rightfully yours. Instead of keeping your money in a savings or investment account where it could earn interest all year, you essentially gave an interest-free loan to the government.

Personally, I'd like to optimize every dollar I earn, so in 2019, I tried to get as close as possible to breaking even on my taxes. In other words, I set out not to get a huge refund by matching my withholding to my true tax liability.

I'm happy to report that it worked - I'm getting my smallest federal refund ever at about $200. That's nearly $780 less than I got back last year. With the extra money in each paycheck, I increased my automatic savings contributions, steadily growing the balance in my high-yield savings account.

If you're investing outside of retirement accounts, having more money in each paycheck to invest greatly increases your chances of building wealth. By spreading out regular contributions over an extended period of time, you're taking advantage of a financial strategy called dollar-cost averaging, which effectively lowers how much you're paying per share for an investment. When you invest a lump sum all at once - like a refund - you're buying into the market at a single price point.

Personal preferences aside, I understand why people would want a big refund. It can double as an instant savings account or help you pay down debt quickly. "For some, that's a perfectly fine strategy, as long as you can cover all of your other expenses throughout the year," Jaeger said.

But if you're interested in growing your net worth, try adjusting your withholdings this year to match your tax liability. You may not be able to buy a car or take a vacation with your refund next year, but you'll have a savings or investment account that's worth much more.

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