How to Adjust Your Withholding

I've suggested several times that everyone should adjust their federal income tax withholding so they do not give the government an interest-free loan each year. You could be earning money on that amount yourself, not to mention putting it to use paying off debts, investing, building an emergency fund, etc.

As such, I've had several people ask me to suggest how they should set their withholding. Until recently, I didn't have a good answer for them. But I ran into this withholding calculator from Kiplinger's and thought I'd pass it along to all of you trying to set your withholding at the right level.

Comments

[Bill D'Alessandro]

There's actually a much more in depth calculator straight from the IRS at this url:
http://www.irs.gov/individuals/page/0,,id=14806,00.html

[EMF]

This is where being able to set up a spreadsheet pays off for me. My witholding situation is complicated by the fact that in order to contribute the over-50 catchup to my 401k, I have to first be contributing at the plan maximum of 30% of salary. I want to maximize my tax-deferred contribution, but do not want to contribute after-tax money to the 401k which the plan allows. I also want to take full advantage of the company match. So my paycheck goes down for part of the year. Also, to compensate for the extra tax-deferred savings, I am converting other tax-deferred funds to a Roth IRA, which increases my tax liability in April of the next year. During the pay periods when I don't have extra contributions to my 401k, I increase my tax witholdings.

So I've set up a table to add up the projected income and witholdings for each payday, and add up an Adjusted Gross Income from which I subtract personal exemption and estimated deductions to predict taxable income, on which the tax is calculated from current year tax rates provided on the IRS web site. I'm also able to predict my 401k contributions so I meet the goals stated above. Last year I came within $50 of the maximum allowable contribution of $20000.

Last year, I ended up with a federal tax refund of less than $5, which would have been about $30 owed to the IRS except for the telephone tax credit. And I'm applying it to this year's taxes, instead of hassling with such a small check.