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I’m a Financial Planning Expert: 3 Reasons You Shouldn’t Rely on Your Tax Refund in 2024

I’m a Financial Planning Expert: 3 Reasons You Shouldn’t Rely on Your Tax Refund in 2024
Casey Bond
February 23, 2024

About three-quarters of taxpayers get a refund each year. That money is often highly anticipated, serving as a much-needed bump in cash flow at tax time.

As of Feb. 2, the IRS issued more than 2.6 million refunds totaling about $3.65 billion. However, the average refund so far this year is just $1,395 — 29% smaller than $1,963, which was the previous year’s average at around the same time.

Why are refunds shrinking? And what can you do about it? Frank Remund, CFP, EA, and principal wealth manager at Savvy Advisors shares the reasons you may not want to rely on getting a big refund this year.

Why Your Refund Could Be Smaller This Year

Here’s a closer look at why you might expect a difference in refunds this year.

Your Taxable Income Increased

Remund noted that tax brackets have recently been adjusted to account for inflation, which reached a 40-year high in 2022. In fact, the IRS increased tax brackets and the standard deduction by 7% for tax year 2023 — the largest single-year increase in decades. That means if your income remained flat last year, you’ll pay less in taxes. However, if you received more than a 7% raise in 2023, you could be subjected to higher taxes, reducing your refund for the year. 

The same is true if you started a business or side gig and didn’t make your quarterly estimated taxes. Or if you’re still working but started collecting Social Security retirement benefits last year, you could see your income taxes increase since the IRS uses your total combined income to calculate tax on Social Security.

You Didn’t Update Your Withholdings 

If you experienced a major life change in 2023, such as a change in the number of dependents you can claim, but didn’t adjust your tax withholdings on your W-4 Form, your tax liability may have changed. Along those same lines, if a dependent reached the age of 17 in 2023, they would no longer qualify as a dependent child for claiming the child tax credit, which could result in owing more.

“Employers in 2023 also may not have switched over to the correct W-4P form for 2023, which they were obligated to do, which may have impacted your deductions,” Remund noted. 

You Lost Certain Valuable COVID-19-Era Benefits

During the pandemic, certain tax credits were temporarily increased to provide additional financial support. For example, the child tax credit (CTC) and the earned income tax credit (EITC) were significantly enhanced. With these benefits reverting to their pre-pandemic levels, taxpayers who benefited from these higher credits in previous years may see smaller refunds.

“The removal of all additional per-person subsidies has undoubtedly had a significant impact,” Remund said. “These changes … likely will impact your tax returns depending on whether you had taken advantage of this in the past.”

Getting a Big Tax Refund May Not Be So Good After All

A big tax refund in April might feel like a windfall, but getting a refund isn’t necessarily a good thing

“By receiving a tax refund, you’ve actually overpaid your taxes for the previous year,” Remund said.

In other words, that refund is money that you earned last year, but didn’t actually receive until the following tax season. So if you do receive a refund, you may not want to treat it like free money to be splurged. At least, not all of it.

“Consider allocating a portion of the refund toward savings, reducing debts and treating yourself,” Remund said. “It could also be the start of establishing an emergency fund, serving as a financial buffer for educational expenses or even a down payment on a vehicle.”

How To Reduce Your Tax Liability

To accurately assess your tax obligations and avoid a surprise tax bill in April, Remund recommends taking advantage of the IRS tax estimator tool.

“By entering your pay stub details with utmost precision, you can ensure an accurate calculation of your taxes,” he said.

There are also several steps you can take to reduce your overall tax liability and ensure you don’t owe at the end of the year. It’s generally a good idea to consult with a tax expert when devising your overall tax strategy, but some ideas for reducing your taxes include:

  • Contribute to retirement accounts: Putting money in a retirement account, such as a 401(k) plan or traditional IRA, can lower your taxable income as these contributions are made with pretax dollars.
  • Invest in a health savings account (HSA): If you have a high-deductible health plan, contributing to an HSA can also reduce your taxable income. HSAs offer triple tax advantages: tax-deductible contributions, tax-free growth and tax-free withdrawals for qualified medical expenses.
  • Take advantage of tax credits: Unlike tax deductions, which reduce your overall taxable income, tax credits reduce your tax bill dollar for dollar. Tax credits you may want to investigate include the child tax credit, the earned income tax credit and certain education credits. 
  • Harvest tax losses: If you invest in stocks or mutual funds, you can sell underperforming investments to realize losses. These losses can offset capital gains and up to $3,000 of other income ($1,500 if married filing separately).