So April 15 has come and gone, and income tax is off your mind until next spring. However, summer is a great time to think about last tax year and adjustments you can make with time for these to take effect before you hit the 1040s next year.
Tune Your Tax Withholding
If you had to pay additional tax, or if you received a large refund, you’ve got a very good sign it’s time to adjust the amount of tax withheld from every paycheck. The relationship is simple. If you had to pay, then you need to withhold more. If you have a big refund, you can withhold less. All it takes is filling a new form W-4 with your employer.
Now, there are those who use tax withholding as a key element of their personal savings strategy, looking forward to that chunk of change at refund time. Despite the feeling of that refund, it’s just not a sound strategy. It’s not a gift from the IRS, it’s your own money that they held for you all year, without paying you a cent of interest. That’s money that you could be using throughout the year, or — perhaps most effectively — money that can be moved from payroll tax withholding to payroll retirement savings.
Bump It Up
Say, for example, your refund works out to about $20 a week. Reducing your withheld tax therefore puts a few more premium coffees into the budget every week. Or, at the same time you’re filing a W-4, you could also change the amount of your contribution to a 401-k or IRA. In that case, you’ve just boosted your retirement savings by $1,000 a year. If you roll your refund into retirement savings anyway, you still come out ahead because your weekly contributions are now compounding interest where previously they’d be sitting with Uncle Sam doing nothing for you.
No April Payment
That’s a great situation if you’re in a refund position. If you have to pay additional tax on your return, changing your W-4 results in a little less each paycheck, but you’re also not writing a big check when you file each year. If you’re making changes in the summer, though, remember that half the tax year is already gone by, so you’ll have to double the amounts of weekly changes to balance the entire year.