A Tax Withholdings Case Study

Last month I had the opportunity to counsel one of my good friends and her husband with their finances.  Upon getting their numbers, one of the first thing I noticed was the very large gap in what I remember her telling me their approximate gross income was and what their take home pay actually ended up being.  Upon further investigation, we discovered that they had been over withholding their taxes by having way too few exemptions.  The result was that for the last several years they have been receiving an average $6-8K tax refund.  I had them adjust the number of exemptions they were claiming on their W-4 and we found an extra $400+ per month to bring home.  That's an extra $4800/year that they really need and that's not being loaned to the government interest free.  I can't tell you the relief that washed over them when they realized they weren't as bad off as they thought.  They were also appalled that they hadn't caught the discrepancy sooner.  They were caught in a vicious cycle of running up debt throughout the year only to try to knock some of it down when the tax refund came in.  Now they are thrilled to have one last big return and have a plan for that money to end the chaos.  Please take a lesson from this real-life example! Make the changes necessary today to take control of your financial destiny.

Tip of the Week February 18-25

Are you getting a tax refund?

The average tax return was a little over $3000 last year, according to CNN Money. This might seem like a really good thing to get money back from the government. I want you to think about this for a minute. One of two things are at play here, and sometimes both. You are either paying in too much money and thus receiving it back or you are receiving money that you didn't pay in the form of credits (earned income credit- EIC, child tax credit and such). Or like I said you are doing both and receiving a very large refund because you are not only paying too much but also receiving the credits.

The credits you really can't control since that's just how things are with the current tax system. You can however control how much you pay in. Here's a hint: if you are consistently qualifying for those credits, in particular the EIC, you should be paying very little if anything from your paycheck. This is because those credits offset any negligible amount you would need to pay. This would mean you make less than average household income ($49K/year) and have children. Add that to any other major deductions you may take- mortgage interest, charitable contributions, medical expenses, Roth IRA contributions. You could really get a bundle back...which isn't necessarily a good thing.

Homework:
So what do you do about this? If you are getting a refund I want you analyze why. Change your W-4 to reflect the proper amount of exemptions to claim. If you are unclear on this please see you tax consultant for the right number and/or talk with your HR director. This may be more or less than the number you come up with using the W-4 questionnaire. Also be sure to update it regularly when you have a change in income, number of dependents or life situation. Your goal should be to get the amount owed or refunded as close to zero as possible. After all who wants to loan the government money interest free for the year.

Quotations of the Month January

"Self-sabotage is when we say we want something and then go about making sure it does not happen." Alyce P. Cornyn-Selby


"A person's worst enemy can't wish on him what he can think up on his own." Yiddish Proverb


"I have never been contained except I made the prison." Mary Evans


"Whether you think you can, or you think you can't, you're absolutely right." Henry Ford

Tip of the Week January 28-February 4

Friends and Family Sabotage

I wanted to end the month talking about another important means of sabotage- friends and family. While trying to accomplish your financial goals, having a good support system around you is very important. For those of you who are single, friends are like a second family. If your friends or family are ridiculing you for the changes you're trying to make, it's pretty difficult to continue. There will always be someone in your life that will try to pull you down. Whether it's a friend, co-worker, or family member, you will have to evaluate your relationship with them. Your true friends will always stand by you and support you through thick and thin.

Homework:
When you're trying to lose weight, the last thing you need is a friend asking you to go eat ice cream. It's the same thing with your finances. Friends wanting you to go shopping, or go out to eat every day can really hurt. If after you have explained to them what you are trying to do, they scoff and continue to pester you or make fun of you for not going with them, then it may be time to evaluate the relationship. If your friendship is defined by spending money that you don't have, find a way to redefine it or separate from that person. Family members can be more difficult to deal with. You may have family traditions of going on a big vacation every year, or spending big on holidays and birthdays. Most of the time the majority of family members will understand, but there might be a few who are offended that you are choosing not to spend money you can't afford. In these cases, developing thick skin may be a necessity.