To illustrate this, let’s assume that beginning in 2017, your tax refund averages $5,500 annually. In the spring of 2018, after your taxes are filed, you receive your refund and invest the proceeds in a Roth IRA averaging an annual interest rate of 8%. After 30 years of investing your $5,500 tax refund, your account will have grown to $623,058.
Now let’s consider what happens if you had adjusted your withholdings so that instead of receiving a $5,500 refund, you withheld the correct amount. Rather than waiting for spring 2018 to receive your tax return, you can begin investing the difference ($449 monthly) in the Roth IRA starting in January 2017. Assuming an 8% annual rate of return, by the time tax season rolls around in 2018, you’ll have $5,736. That’s $236 more than you would have received with the large tax return. Compound this return for 30 years, and your account grows to $649,739. Simply adjusting your withholdings earned you an additional $26,681!
Paying attention to your allowances and withholdings is an easy opportunity to improve your investment returns without taking additional risk or saving extra money. If you consistently owe or receive more than $1,000 on Tax Day, speak to your financial advisor or tax professional to appropriately adjust your allowances and withholdings.