Are You Making a Costly W-4 Mistake?

Tax refund, those are nice words, aren’t they? We all love getting money, especially at tax time. No one likes finishing their taxes and finding they owe Uncle Sam money they don’t have. Are you making a costly mistake when it comes to getting a tax refund?

According to the IRS, in May 2013, the average refund for Americans was $2,651. That is roughly $221 per month, money you are lending to the government for free. You earned it and you have the right to spend or save it. Why are you lending it for free?

Many people say they treat taxes and the potential refund like a savings account; a guarantee of a rainy day fund that comes in April or May depending on how quickly(lazy) you are with doing your taxes. It is nice to have a rainy day fund and to get a windfall just as summer is about to begin, but is this a money conscious move?

If you are trying to pay off debt, this is the wrong move. What often happens when you get that refund? Come on admit it, you spend it right? Does that help your financial situation? If you do apply it to your debt, that is a smart move. What if you had been applying that $220 to your cards each month? Would your debt be paid off? If you did out the $220 towards your debt each month, you also reduced finance charges.  That $2,651 tax refund saved you more because you didn’t pay these extra charges.

How can you get more of your money with each paycheck? It’s simple; add deductions to your W-4 – you can obtain a W-4 from your human resource department. When most people start working they don’t have and don’t claim dependents. Even without dependents, workers may claim them on their W-4.

Uncle Sam likes borrowing money for free, so he doesn’t give advice that prevents that from happening. He does provide a calculator to help a little.

We recommend playing with the calculator. Include your current number of dependents in the calculator, and then add an additional dependent. If the difference between the two is close the balance of your tax refund from last year and you don’t expect your income to drastically change, add the dependent on your W-4.

If you’re still concerned about owing Uncle Sam, you have two options. The first option is to adjust your W-4 twice a year; increasing the dependents for only half the year. If you choose this option, don’t get comfortable with the temporary higher income. This could cause you to over spend. The second option is to put the extra money into an emergency savings or tax savings account that earns interest. This lets you earn the interest and not Uncle Sam.

Our recommendation is to make your money work for you. This is what the rich do. If you are in credit card debt, send the extra monthly amount to your credit cards. Send it before you spend it! If you are not in debt, increase or start putting money into a pre-tax retirement account, such as your company 401(k) or an IRA. This will not only decrease your taxes, but allow you to save more for retirement. This is something too few Americans are doing. If you are already maxing out your 401(k) or other retirement accounts, invest this money in a taxable account. Your money should work for you and not Uncle Sam.

Lastly, before making any changes, check with a tax advisor.  Each of our situations is unique and seeking the advice of a tax advisor that understands your situation is best.

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