At tax time everyone hopes for one of two things. “Please don’t let me owe!” or “I want a really big refund!”
The American public doesn’t save money the same way it used to. In the last forty years we have gone from a generation of one-income households on average, to households with two or more incomes. Today, it does not necessarily take more money to live, but it does take more planning.
Withholding too much Federal Income Tax?
One way that Americans have “tricked” themselves into saving money is to have a greater than needed withholding on their Federal Income Taxes. Many people think of their tax refund as a savings account for vacations or major purchases. Having a big refund can be detrimental in many ways. First, let’s look at what is actually happening when you have that big refund.
Money you could be Saving
When you have extra withholding taken out of your paycheck, your are complying with the IRS’s pay as you earn policy. The IRS does not want you to owe at the end of the year and that is understandable. However, paying in more than you would owe at the end of year in order to attain a big refund allows the government to invest that money and earn interest. Essentially, you are handing the government an interest free loan on your hard-earned money.
Save Withholding Tax Yourself and Earn Interest
Let’s say you want to save up all year for a vacation in the spring next year. Why not take that extra withholding and put it into a regular savings account or build it up and buy a six or twelve month CD. Even if you make only two to four percent interest, that is more than you would make on that money by loaning it to the government all year. Major purchases will feel more rewarding when you have conscientiously saved your money and gained a little interest as well.
Adjusting your Withholding Amount
Want to put a little more in the savings account and a little less in Uncle Sam’s coffers each year? Do a little research. Looking at what your typical refund would be without the extra withholding is a good start. Are you taking advantage of all of the credits, adjustments, and deductions that you are entitled to? It is entirely possible to claim one or two of your exemptions on your paycheck and not feel a pinch at tax time. This extra income into your household can be invested, paid against high interest credit cards, or any variety of tight places in your monthly budget. Carefully review your personal situation or consult a Tax Professional before making any changes to your withholding to make sure that you do not under estimate and end up with a big balance due.
Save — Don’t Spend — the Tax Refund!
One other thing to think about is the spending frenzy that the average person will go into when handed a big check. You may have thought that you were going to go on vacation, but if you spend half your refund on digital camera equipment because you haven’t been able to spend all year, there goes your plan. On average, a tax refund of over two thousand dollars will get spent in its entirety within five days of the receipt of the money.
The biggest reason that people say they have larger withholding than necessary is that they lack discipline to save on their own. If this is your case, check out your human resources department. Most companies offer automatic deposits and you can have your extra withholding placed in your bank, not Uncle Sam’s. Again, do a little research and find the highest interest bearing account to place your money. Watch your money grow on your terms and feel the freedom of planning for the future – with interest!