An easy way to quickly get more money in your pocket is to increase the number of withholding allowances on Form W-4. By doing so, you don’t change your income. You just change the timing of when you receive your money. In the past, a compelling argument could be made to avoid receiving a large income tax refund because you could’ve earned interest on those funds during the year.
With high yield savings accounts paying interest of 1.o% to 1.5%, that argument isn’t as convincing as it used to be. Toss in the fact that you’re required to pay ordinary income taxes on that interest, and you’re almost back to zero anyway. But giving Uncle Sam an interest free loan is far more sinister than it appears.
I volunteer to teach a budgeting class for Capital Area Asset Builders, a Washington D.C. not-for-profit that focuses on helping people develop and improve money management skills. During class, I’ll bring up the importance of adjusting withholding allowances in order to receive money evenly throughout the year. You’d think I suggest the class participants cancel their cell phone service based on their reaction to this advice.
What’s so bad about receiving your money as you earn it?
While Big Brother is having his way with your hard earned cash, here is what you’re not doing:
- You’re not paying off high interest rate debt. Forget about earning a measly 1.0% on your savings account. Credit card companies aren’t shy about charging interest rates of 20, 25, or even, 30 percentage points. That interest-free loan to the government doesn’t cost an innocent 1.0%. It costs what you paid in interest to American Express, Sallie Mae, and any other creditor you borrowed money from.
- You’re not buying the things you need/want during the year. I’m a big believer in delayed gratification. However, if you take a portion of your income tax refund and purchase a washer/dryer after year-end, then why’d you inconvenience yourself with hauling clothes back and forth from the laundromat all year? That doesn’t make any sense.
Here are the three most popular excuses for continuing to get a big income tax refund:
- “It’s a forced way of savings. I’ll just blow that money if I receive it throughout the year.”
- “I might end up owing the government thousands of dollars at year-end if I miscalculate how much I owe in income taxes.”
- “I’ll still get a huge refund, because I can’t claim more than 10 withholding allowances.”
Hogwash!!! All of it!
- Have the extra funds direct deposited into a savings account from your paycheck with a bank that’s completely separate from the financial institution that holds your checking account. Your employer doesn’t offer this perk? Then have that money automatically transferred from your checking account to your savings account (again at a separate financial institution) no more than a business day or two after you receive your paycheck. If your bank is so antiquated you can’t set up automatic transfers, then get with the times, and find another bank.
- If your income, deductions, and credits are fairly consistent from year to year, then I wouldn’t worry too much about owing the government a large sum of cash come April 15th. If you’re still nervous, check out Dinky Town’s income tax calculators to get a better idea of your tax obligations. To further reduce the risk of being hit with a large tax bill, adjust your withholding allowances so that you only receive 50% of the previous year’s refund during the current year. For instance, if you received a $5,000 refund in 2008, then try to get an extra $2,500 in your paychecks during 2009. Use the Payroll Deduction Calculator at Dinky Town to see how changing your allowances impacts your take home pay.
- You can claim as many withholding allowances on Form W-4 as necessary to ensure you’re paying the appropriate amount of income tax. Many companies allow you to change your W-4 over the Internet. Some organizations cap the number of allowances you can claim on an electronically submitted W-4. Here’s what you need to do if your employer is one such organization: 1) Print out Form W-4. 2) Fill it out. 3) Walk your lazy self over to your company’s human resources or payroll department and turn the form in. It’s that simple.
I actually think it’s better to owe the government money, but not so much you’re penalized for underpayment of income taxes.
Do you receive an income tax refund every year? Why haven’t you adjusted your withholding allowances?