The best time to give your tax withholdings a checkup

Well, we did it. We survived another tax filing season. If you work for an employer, you probably don’t have to think about taxes again for another year.

Unless… 

Did you wind up owing more than you expected (or more than $1,000)? 

Or did you get a refund of more than $2,000? 

If so, you might want to give your household’s tax withholdings a checkup. (This is specifically for people who work for an employer.) It’s a little bit of a hassle, but like most hassles, it’s more bearable when you’re prepared and know what you need. And right now is the best time to do it, from a convenience perspective – because you just used all the relevant information to file your taxes!   

Ok, before you start, I actually like getting a huge refund.

You might be tempted to max out your withholdings so you are guaranteed a big refund. While that psychologically kinda feels like you’re winning the lottery, over-withholding too much tax = lending the government your money, except they don’t pay you any interest on that loan. (Rude.) If you are getting a refund bigger than about $2,000, that is a full year’s worth of not having access to a LOT of your own money. 

You deserve access to your hard-earned cash when you want it and need it. Not just when you get your refund.  

One year, when I was a silly young thing, I was so shocked to find out I actually owed money that I was certain there must have been some kind of mistake. I had absolutely no concept of a tax filing that didn’t include a refund.  I – like so many of us – had been conditioned to assume that tax time = getting money back, and found myself subconsciously counting on that money. 

I don’t want that for you. I want you to get a little bit back, but I also want your income in your control all year long. I want you to be the boss of where your money goes, instead of relying on the government holding your cash hostage as a savings strategy.

If you like the aspect where it’s totally automatic and that helps you out, that’s ok! If you’re currently over-withholding, you can easily recreate the automation. Withhold the same amount yourself, ask your company to split your paycheck, and route that money over into a high-yield savings account. Instead of spending the year in federal custody, those sweet dollars quietly add up to help you build your emergency fund or save for a goal. (Or a treat. Treats can be goals too.)  

If you have read all this and are opting for Operation Huge Refund anyway, we can still be friends. But it becomes even more important for you to make a plan for that refund so it doesn’t just disappear. (And yes, the plan can be treats. They’re just intentional treats instead of impulsive ones!) 

Why don’t I just set up my withholdings so I keep ALL my money all year and pay the bill when tax season comes around?  

That is a great question. Gather round the glowboxes for a story of April 2020.  We sat down (virtually, because, April 2020) with our CPA, Susan. She proceeds to tell us that we owe over $5000. 

Thank goodness for our emergency fund, because that was NOT fun.

Someone (I’m not going to say who, but it was Mr. Fortuna) had started a new job and had not accounted for our whole household’s earning picture when he set up his withholdings. Susan was slightly shocked that we hadn’t been penalized with a bill that big. And I was slightly shocked to find out that accidentally withholding too little tax can lead to an underpayment penalty. (Fun fact, the IRS charges interest on underpayments, even though they don’t pay you interest on your refund.)

We wound up owing Uncle Sam a little less than $100 this year, which felt impressively accurate, although much closer to $0 than we were expecting. We’d calibrated our withholdings so we’d get something like $2000 back, but like many parents, we found the size of our refund was affected by receiving the Child Tax Credit payments throughout the second half of 2021. While it was nice to get a “prepaid refund,” we hadn’t really been thinking of it that way, and if we’d been withholding too little, we might have wound up owing.

Yikes. So, hypothetically, what do I need to know to get my refund in the sweet spot?

Here’s a checklist of what you need to excavate for your checkup:

  • Your most recent tax returns (federal and local).
  • Your most recent pay stubs (for you, and your spouse if married) for any jobs held during the calendar year.
  • Information on any bonuses you have received or may be expecting later in the year.
  • Earnings information for any non-W-2 income sources. This means social security benefits, unemployment, scholarships/grants, self-employment, investment income, annuities, alimony, distributions from retirement accounts or trusts, and any withholdings or estimated tax payments already made on any of the above.
  • This link: https://www.irs.gov/individuals/tax-withholding-estimator.
  • Probably a calculator or a spreadsheet.

If you’re just starting a new job, you should be prompted to file a new W-4 “Employee’s Withholding Certificate” right away. If you’re fixing your existing withholdings at a current job, you’ll want to work with your job’s finance/payroll rep or system to file a new W-4. 

When you set things up, we would recommend (for most people) that you calibrate your withholdings to get a refund of about $1000-2000. If you have a complex tax situation or just don’t feel like getting your hands dirty, this doesn’t have to be a DIY project. CPAs can absolutely support you in getting your household’s W-4s dialed in, especially if your situation is at all complicated – and if you used a CPA to file your taxes, they can do all this for you with almost no extra effort on your part.

Is this a one-and-done?

It is worth doing an annual review, especially if you (and/or your spouse) has experienced any major life changes:

  • Any change in income during the year (added another job, gotten a raise, dropped to part time, got a huge bonus, whatever) 
  • Marriage/divorce
  • New babies
  • Big kids age out of “dependent” status
  • You bought a house 

Although you can update anytime you experience one of those changes, I’d probably do it sometime between the beginning of the calendar year and right after you file your taxes. Don’t forget your state taxes, either! Many states that collect income tax offer an online state withholding estimator (North Carolina does).

If you need help figuring out how to prioritize your extra withholding money — or your Huge Refund — I’d love to sit down with you for a complimentary Big Financial Picture session and see where you can make the most of it!

Big thanks to my beta reader Casey Jean of Jean’s Apothecare, who handcrafts sustainably made teas and botanical goods and who has also created over five hours of totally free meditation and mindfulness resources as part of her commitment to wellness accessibility. A compassionate, grateful, and relaxed mindset is really good for your financial wellness, too — check her out! (Also, her Instagram game is fire.)

Header photo credit to Pixabay on Pexels.com.

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