Note: None of this should be taken as legal advice. In addition, life changes, such as raises, promotions, marriage, or kids, may result in a higher or lower taxable income. It’s best to consult a professional to see what is best for your individual situation. See my disclaimer for more information.
“In this world nothing can be said to be certain, except death and taxes.”
- Benjamin Franklin
I think old Ben hit the nail on the head with that one.
This past Tuesday was tax day here in the United States. This is the final date that we can report our earnings and tax payments for the previous year to the IRS.
For some, it was a good year and you got a big tax refund. For others, you had to owe some money to the government. For myself, I consider it a good year because I didn’t owe the government anything, and my tax refund wasn’t too big.
One of the best things you can do for your money is to adjust your tax withholdings. The goal is for you to not only owe the government nothing, but the government also doesn’t owe you much.
But for some, that’s a hard pill to swallow.
Many of us really enjoy getting a tax refund every year. Who doesn’t like to get a $1,000, $2,000, $3,000 or more check in the mail every year? Feels good!
It may not be the best for you, though.
I Get it
I understand that some of you may like getting a large tax return. Believe me, I get it. I used to be the same way.
By now, I’m sure you’ve heard all of the reasons why you shouldn’t be getting a big tax return such as:
- You’re giving the government an interest-free loan
- The government will never be as good with your money as you are
- Why wouldn’t you want that money in your paycheck?
There are many others. These may not speak you.
For many of you, it may be a form of discipline—a way to save that money every year or put it towards something of worth while. It may be a way to pay for a vacation when you otherwise wouldn’t have the money. For others, it just feels good to get that check.
But did you know there’s a different way to do this exact same thing while still keeping the money in your court (i.e. under your control)?
Automatic Savings Transfers
Automatic Savings Transfers give you the best of both worlds. You won’t be able to use the money for anything, but it’ll still be yours, earning you interest along the way.
For this to work best, you should open a savings account specifically for this money where it will be difficult for you to touch it. If you’re disciplined enough, you can keep this in the same bank that you currently have your checking account. To keep yourself from getting to it, try opening a savings account at a separate bank or at an online bank.
Hopefully, I’ve piqued your attention. The only thing you won’t get is that big check, but you’ll have a nice sized chunk-a-change in a savings account (earning interest!) in a year.
For this to work, though, we’ll need to figure out how you can adjust your tax withholdings to get that money back on your paycheck to transfer out to your savings account.
Let’s get started!
Figure Out Your Current Tax Withholdings
Start by going to paycheckcity.com and entering in your current payroll information. Your payroll information will be on your most recent check stub.
On the homepage, you’ll be presented with a row of options that look like this.
Select the salary or hourly paycheck calculator based on if you are a salaried employee or not. The only difference between the two is that the hourly calculator adds an extra section called “Rates Information.” You put in your hourly rate in this section and it calculates your gross pay in the “General Information” section instead of manually entering your gross pay like in the salary calculator.
By selecting one of the two paycheck calculators you’ll be presented with a screen that looks more or less like this.
The date isn’t going to matter for our purposes so go ahead and start by selecting the state you live in. After you select your state, continue by adding your salary or hourly information.
Remember, if you are in the hourly calculator you’ll have that extra “Rates Information” section to be able to enter your hourly rate. This will auto-populate the Gross Pay field and defaults to the gross pay per pay period. This is fine unless you want to see how much you make a year.
You’ll want to enter the number of hours you usually work in however long your standard pay period is. So if you get paid every two weeks and always work 80 hours in that two week period, you’ll want to put “80” in the Hours #1 field.
After entering your pay information, select your filing status, the number of federal allowances you currently claim, and if you have any additional withholdings or are exempt from any. For example, my filing status is Married and I currently claim 3 allowances on my federal taxes. I have no additional withholdings and am not exempt from any taxes.
Next, enter in your state information. Depending on your state, this section will look a little different. Illinois looks like this.
After you enter your state info you’ll come to the “Voluntary Deductions” section. This is where you enter in your medical premiums and deductions, things like public transportation monthly passes, or anything else that can be taken out of your check before taxes are taken out.
There are buttons to add or remove deductions if you need to do so. Don’t forget to change the drop down from percentage to fixed amount for deductions that are set dollar amounts like medical premiums.
I have deductions for a 401K, medical, dental, vision, and a monthly train pass. All of these lower my taxable income each check. If you have any of these taken out of your paycheck, it might be worth checking to see if your employer offers any pretax deductions on them.
After you are done with your deductions or determine you don’t have any right now, select the “Calculate” button at the bottom.
When the paycheck information loads, it should match your current paycheck (it may be off by a few pennies).
Note: When you hit the back button to go back and adjust your amounts, the deduction information does not stick. The dropdown changes—such as changing from percent of gross to a fixed dollar amount—should remain. However, you’ll need to reenter in your name and amount.
For this part, you’ll need to know how much your tax refund was this year for both state and federal. Let’s start with federal.
Divide your federal tax refund by the following:
- If you get paid weekly, divide your tax refund by 52
- Divide by 26 if you get paid every other week (26 times a year)
- Divide by 24 if you get paid twice a month (24 times a year
The goal is to gain as close to this amount on each paycheck as you can without going over. You don’t want to go over so you don’t owe the government anything. As an example, if you received a $1200 tax refund and get paid 24 times a year, you’re going to want to adjust your holdings so you get as close to $50 as you can added back to each check without exceeding that amount.
For this part, we’re going to be concentrating on the “General Information” section, specifically the field titled “# of Federal Allowances.” Unless your refund was $2,000 or $3,000, it’s best to start small with the changes in your deductions.
Hit the back button or open a new browser tab and change your number of federal allowances to 1. Double check to make sure your deductions are correct again and then hit the “Calculate” button.
Is your paycheck amount high enough to cover the number you got when dividing your tax refund by how many times you get paid?
If it is, then you’re done! If not, let’s try upping the number a bit.
Hit the back button again and change the number of federal allowances to two or three, depending on how far off your paycheck amount was from your goal. Repeat this until you are close to your amount but not over it. If you try a federal allowance of 3 and it is over the dollar amount you are shooting for, then you know that you can claim a federal allowance of 2 and not anymore.
Write this new federal allowance down somewhere so you remember it. Also, write down how much you are gaining on your check. This is the amount that you will be automatically transferring to saving.
Adjusting State Withholdings
You can apply the same process your state withholdings as you can with federal. Grab your state refund amount and focus on the “State and Local Information” section.
If you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming, you won’t even have to worry about this section. Due to those seven states not having state income tax, this section will be completely blank.
For the rest of you, input your information as you would your federal allowance. For Illinois, I focus on the basic allowances. I claim 2 for those. Your state may vary on what field you should be looking at.
As soon as you figure out what you can claim for allowances on your state income tax, write this number down with your federal allowance.
Again, write down the dollar amount of the change to your state tax on your check. We’ll add this to the amount we’re already going to be transferring automatically to savings from federal.
Now, that we have all of that out of the way, you can make these changes with your employer. Again, be advised that your tax situation may change mid-year, and it’s always best to consult a professional before making changes. I felt pretty confident in the changes I needed to make so I went ahead and changed them with my employer.
You will more than likely have to fill out a new W-4 for your federal insurance. Some companies let you make changes electronically to federal. My company allows me to change federal electronically, but for state, I have to fill out a new form. Your mileage may vary.
After filling out the new forms, determine when this will take effect. Depending on your companies payroll system, it could take effect the very next paycheck or take two or three pay periods to update.
Set Up Automatic Transfers
The reason for determining when these changes will affect your paycheck is so you know when to start the automatic transfers! Setting up an auto transfer for this new money on your paycheck will have the twofold effect of still feeling like you are not seeing the money as well as allowing you to earn some interest on your money.
Depending on your company, you may be able to set up automatic direct deposits into more than just your checking account. My company allows me to send to my checking account and up to 3 other accounts. I have the option to automatically transfer from my check to a savings account so the money literally never hits my checking account. This is the most ideal situation.
If your employer can only direct deposit your check into your checking account, or does not offer direct deposit, you can still set up recurring bank transfers from your checking account to your savings account both inside and out of your bank. Consult your bank for more information.
The Best of Both Worlds
Many people like to get a tax refund and I completely understand why. It’s a financial adrenaline shot to the arm when you get a big check. Now, you can all of a sudden pay off a bunch of debt or go on a nice vacation. You may use it to bolster your emergency fund or investment accounts and feel like you have more discipline to use it how it’s intended if you get it all at one time.
At the same time, you’ve heard it said that it’s an interest-free loan and that you are earning literally nothing on that money you could have had throughout the year.
Adjusting your tax withholdings and then setting up automatic transfers to remove that money from your check without you seeing it is the best of both worlds.
You get to keep your money in your hands, but you also get the same feeling of not having that money because it’s removed from your checking account. Give it a try! I promise you won’t regret it.
Anything to add? Comment below!