Are you looking for a quick way to increase your savings or find some extra money to pay down debt? If you are like millions of other taxpayers currently overpaying your income taxes to the IRS each year, you still have time make adjustments to how much you are sending Uncle Sam. The average refund was $2,827 in 2020 with over 125 million refunds issued. This is a substantial amount of money to be loaning out to the IRS at zero percent interest.
It may sound a bit too early to be thinking about filing your income tax returns for the 2022 tax year. But when you factor in the possibility of taking home an extra $220 per month or more, an adjustment to your tax withholding may be a smart move to make. Here are some key life events that trigger a need to adjust your tax withholding:
- You or your spouse has a change of income. Landing a job with a new employer, self-employment, getting a second job, and performing contract work on the side are all changes in household income that may require you to modify your allowances. Temporary unemployment or a reduction in hours worked or salary can also alter your taxes owed for the year.
- Your marital status has changed. Getting married can change your income tax rate and a coordinated tax plan is needed, especially if both spouses are working. Similarly, getting a divorce also changes your tax filing status and will likely impact some tax deductions and other benefits.
- You have a new addition to the family. Having a baby or adopting a child is a major life change and a major tax change as well. In addition to having the ability to claim an additional allowance for a dependent, you may now qualify for the Child Tax Credit, Child and Dependent Care Credit, and other tax credits or deductions.
- You have experienced a change in financial status over the past year. If you’ve experienced a life event that has created financial stress in the form of debt or cash flow constraints due to unexpected expenses, it may be time to re-evaluate your tax planning strategy. Perhaps you’ve been relying on an income tax refund as a forced savings account. The good news is you can gain faster access to your money with a few changes to Form W-4.
In order to make changes to your withholding, you will need to fill out another Form W-4 and provide this form to your employer. However, prior to making any changes to the W-4, you should review the IRS Withholding calculator to estimate the correct withholding for you and your family’s situation. If you are looking for a second opinion or just want to double check your entries, you can also use the TurboTax W-4 Withholding Calculator. With both calculators, you will need to have your most recent pay stubs and a copy of your 2021 tax return if available. Then after you have estimated the correct withholding, you will simply need to complete a new Form W-4 and submit this to your employer.
Always remember the core reason for making changes to your tax withholding is to put your money to work for you as quickly as possible instead of dishing out an interest-free loan to the government. This strategy can help you start paying down high interest debt faster or start building up emergency savings or even savings for retirement. But it only works if you actually use this extra boost to your take home pay the right way.
Many people use their tax refunds as a way of protecting themselves from bad decisions. That’s why it is important to have a spending plan in place and automate things as much as possible. For example, if you expect to see an extra $100 in your paycheck, you should immediately setup an automatic transfer to a savings account or an automatic payment to your credit card. This will help to make sure this extra money goes to its intended purpose.
Any significant changes to your W-4 should be reviewed again before the end of the year to verify that you are still on track to have sufficient taxes withheld for the year. A follow up review could be scheduled later in the year to give you enough time to make adjustments as needed.
As my colleague Greg Ward points out, don’t wait for next year’s tax refund. With a few small changes on your W-4, you can start taking a more proactive approach to managing your finances. The key is to have enough tax withheld so that you either get a small refund or only owe a small amount. It may take some time and a few adjustments to get things right but this is a great way to let your money start working harder for you while putting it into your hands sooner without waiting on Uncle Sam to return it to you.