Like to make easy money? Me too. Here's how:
1. Adjust your federal income tax withholding so you owe no taxes at the end of the year and get no return.
2. Take the money each month ($212.33 on average -- more on this later) that would have gone to the government and put it into an interest-bearing account at 5% (you may be able to do better, but I picked 5% for ease of calculating.)
3. At the end of the year, you'll have $58.44 more than you would have otherwise.
If instead you invested that money and it returned 8%, you would have $93.51 more dollars than you would have had otherwise.
Now think about how much extra money this would be over 20, 30 or 40 years of a working career.
Ok, so these amounts aren't fortunes, but you get the idea. And why let free money pass you by.
What's spurring this suggestion from me? I recently saw that income tax refunds are averaging $2,548 so far this year. The details:
With nearly half this year's tax returns filed, the average refund is up more than $100 from last year at $2,548, Internal Revenue Service Commissioner Mark Everson said Tuesday.
Everson, in remarks prepared for a House hearing, said the tax agency had issued 50.5 million refunds out of the 60.9 million returns received as of March 10, for a total of $128.7 billion. He said the average refund was up about $125 from last year.
Why give the government an interest-free loan? Adjust your withholding and get your $58!!!! ;-)
By the way, anyone out there know of any good calculators that help people set their withholding to the correct amounts?
I know that I am not responsible enough to do that. For many people it seems like a great idea that if done properly will have no effect on their finances. I know I am paying a penalty for a refund, but in my mind I need the mentally forced savings or I will find other things to spend all or part of the money I would save during the year.
Posted by: John M | March 30, 2007 at 08:29 AM
If you end up owing more than $1000 at the end of the year, the IRS will hit you with a penalty--I think the minimum is $25, so if you owe $1001 at the end of the year, you'd pay $1026. I'm not sure what the effective interest rate of the penalty is, but it's much higher than what I get paid on my savings account.
Guesstimating your taxes is very difficult to do if you're self-employed, or if you make changes to your taxable investments during the tax year, triggering a lot of capital gains tax.
I make sure my withholding from any W-2 jobs plus estimated tax payments equal at least 100% of last year's tax to get into the safe harbor that allows you to avoid a penalty for underpayment of estimated taxes.
Posted by: segfault | March 30, 2007 at 08:57 AM
I personally have used the calculator at http://www.irs.gov/individuals/page/0,,id=14806,00.html and it seemed to do well for me.
Posted by: BB | March 30, 2007 at 09:31 AM
I had no idea how my taxes would fare this year after buying a house, getting married, having self-employment income, and my wife quitting her job and going back to school. We wound up with a few thousand back federal, but owed $600+ state. This year is going to be just as wildly different from last year as the last year was to the year before.
Posted by: Blaine Moore (First Time Home Owner) | March 30, 2007 at 09:58 AM
I've used this one: http://www.kiplinger.com/tools/withholding/ It's not as involved as the one BB posted, which means it's probably not as accurate. Our taxes were bittersweet this year. We expected a return, but got back less than $100 (net from the states and federal...owed the feds). But we jumped a tax bracket, lived in two states, each worked two jobs (for a total of 5 W2's). So the bad part was that we expected a return. The good part was that we didn't get a big one meaning that we received all of our money.
Hey Blaine, I know you from another board. ;)
Posted by: Scott Kustes | March 30, 2007 at 10:26 AM
BB beat me to it.
Hey kids, remember to adjust your withholding when you get that COLA/raise, bonus, or any other taxable income!
Posted by: tinyhands | March 30, 2007 at 11:36 AM
I set up a spreadsheet with an entry for every payday's income and withholding, and estimated my interest income and deductions and calculated what my taxable income and the tax on that income would be.
I adjusted my withholding mid-year to cover my taxes with a planned Roth IRA conversion of $13K. Expected to owe about $100, but it turns out that I overpaid by $5 after factoring in the $30 refund of telephone taxes.
Spreadsheet method works well for someone like me who does my own taxes and has even a modest ability to set up a spreadsheet.
Posted by: EMF | March 30, 2007 at 01:20 PM
Actually, the savings for many could be more than $58.44.
That is for those who use the government to enforce savings through the year, but then are so anxious to get their money that they pay usurious interest rates for a refund anticipation loan.
Posted by: EMF | March 30, 2007 at 04:05 PM
As a CPA I have a leg up on predicting all this rather correctly but I err on owing a little more than getting a refund.
When people ask "how we do it?" - survive with kids on 1 income - this is a big part of it. We don't let the govt hold $2k-$10 of our income all year long, unnecessarily. $2k - $10k being the average refunds my friends will inevitably brag about every year - and go spend right away. It's such a weird mindset to me. Like it is a free gift rather than your hard-earned income. To me $10k is a full ROTH contribution next year - for my husband and I - but I am a weirdo, because I rather invest in my future than blow $10k.
The IRS online calculator is rather good - I recommend it all the time.
Posted by: Teri | March 31, 2007 at 05:12 PM
My biggest wild card is capital gains. I withhold too much from my salary to account for capital gains I'll get throughout the year.
Posted by: Reb | April 01, 2007 at 11:02 AM