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Wednesday, February 29, 2012

Your W4 and Extra Cash

When you go from being single to being married and having kids a lot changes. One thing we may forget to change is how many withholding allowances we are claiming on our W4s. Quick Note: W4- is what you fill out when you start a job; W2 is what your employer reports as your wages for the year.

Folks love getting a tax return, but if you get a return, Uncle Sam is just holding your money and not paying you interest. If you are used to getting a hefty return, its time to make a change.

In my opinion, you want to pay enough taxes every paycheck so that you do not owe any money on April 15. However, you want to use your allowances wisely so you can minimize your tax return as much as possible so you can start making that extra cash work for you. Basically, you want to break even- or close to it.

So what do you claim?
My best advice is to use the calculator on the IRS website. You will need to have access to your most recent pay stub (which should have most of the information you need right on it) that includes: total federal income tax paid to date along with what was taken out of your most recent paycheck. You will also estimate the amount of bonuses or non-wage income you anticipate earning throughout the year. Have your child care expenses handy along with any student loan interest you may still be paying as well.

Even if you plan to claim more than the standard deduction with your itemized deductions (frequently the case if you own a home and/ or are paying off student loans), I would recommend still using the standard deduction in the calculator to play it safe (remember, we don't want to owe taxes!).

The calculator will tell you what the recommended withholding allowance is for your situation- placing you as close to breaking even on your taxes (assuming the information you entered is accurate). You can run with that number, or if you are not sure you entered everything 100% accurately, you can always reduce it. Not very mathematical, I know... but we would all rather be safe than sorry. If you are married, with one person employed, and 2 dependent kids- the calculator may tell you to claim 8, but maybe you claim a 5 or 6. That's still a big difference from the 1 or 2 (or even 0) you were claiming before!

So you know that your should take that extra money and make it work for your family. If you cannot make that commitment, and you use it for frivolous expenses... it may well be in your best interest to claim 1 or 2 again-assuming that you were using that tax refund for something productive. However, many people tend to use the bulk tax refund for something fun... instead of throwing it into savings. Its usually easier to save and not blow it if you are doing it throughout the year rather than getting a lump sum once a year. Sound familiar? "Oh, I can use just a little of that to buy that new tv... and I will save the rest!"

What can you do with that extra monthly income? If you were living with all your necessities before, there is no reason to blow this extra cash... make it work for you!

  • Increase your retirement contribution- we should be aiming to save 10% pre-tax in retirement. Maybe open that Roth IRA you have been procrastinating on!
  • Reduce high interest debt (credit cards etc.).
  • Open a 529 college savings plan for your kid(s). Many plans allow you to start with a mere $25 a month. Check and compare all the states that have a college savings plan at College Savings Plans Network.
  • Add to (or start) your emergency fund. Aim for 6 months of expenses.
The key here is to set up an automatic payment plan for whatever it is you decide, whether its saving or paying down debt. Do not let it sit in your checking account long (or at all) and risk it being spent on things you don't need!

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