Here’s Why You Should Adjust Your Tax Withholdings Early

by TK Sanders

Many folks believe that tax refunds or tax bills arise in April without much rhyme or reason. Taxes can be a mystery to many, which is why they simply follow the paperwork guidance and trust in the process. But with a little bit of forethought and planning, any taxpayer can use the system to his or her own advantage. It starts with adjusting withholdings early and often.

All sorts of life changes affect your taxes. Buying a home, having a child, changing jobs, or even earning a raise will all affect your eventual tax burden; sometimes in positive ways for your bank account, and sometimes not. The goal come tax time for most people is simple: don’t owe the government any extra money. But to guarantee they achieve that goal, most people also overpay during the course of the year, which triggers the refund.

A tax refund is never “free money.” It was always your money, that you earned, and that the government was simply holding while you waited for it (and may have needed it along the way during the prior year). Tax withholdings are just a safety net, but there is no rule saying that you must live your financial life with a safety net. Understanding your most likely eventual tax burden and then withholding accordingly will put more money (your money) in your pocket earlier.

How tax withholding is calculated

When starting a new job, employers require new hires to complete a W-4. The W-4 simply instructs the company how much of your paycheck to withhold from each pay period. The employer does not know your personal tax situation — maybe you own rental properties, or have an annuity, or got married — so it is up to you to estimate how much money in taxes you will owe the following year. The W-4 is simply a tool for estimation, cross-referencing, and then withholding by your employer.

And filling out a W-4 is not a “one-time-only” exercise. You can adjust your withholdings as much as you’d like throughout the course of the year. For example, maybe you’re about to work a few weeks of overtime shifts; which will bump your average paycheck up significantly in the short-term. In that scenario, you may want to withhold less money than the normal percentage. Why? Because you know at tax time that you will have over-withheld due to the extra shifts. This way, you actually pocket the extra money you earn in the short term. And you can then invest it immediately, rather than waiting to get it back from the government next year.

That’s the entire game: figuring out ways to hold onto your own money throughout the year, instead of waiting. If you need help estimating your future tax burden, ask a professional for a consultation. Also, you can adjust your W-4 as often as you’d like; just ask your HR representative for assistance.

“With interest rates finally set to rise, earning next to nothing on certificates of deposits and savings accounts may become a thing of the past,” said George Gagliardi, a Lexington, Massachusetts-based CFP and financial advisor at Coromandel Wealth Management. “So why give the IRS an interest-free loan by over-withholding taxes?”