Scripture instructs Christians to pay their taxes faithfully. "If you owe taxes, pay taxes" (Romans 13:7 NIV)
We're also to pay our taxes respectfully, because "the authorities" — whose salaries are paid by tax revenue — "are God's servants, who give their full time to governing" (Romans 13:6 NIV).
But there is no biblical requirement to pay more than we owe. Yet every year, millions of Americans do just that, by setting their income-tax withholding too high.
Sure, they get the "excess" back months later when the IRS sends out tax refunds. But by making what amounts to an interest-free loan to Uncle Sam, these taxpayers are forfeiting the opportunity to earn a return on their money.
This year, 96.3 million Americans (more than 80% of all taxpayers) received an income-tax refund averaging $2,887. That means, on average, these workers overpaid the IRS by about $240 a month in 2009!
Here's the truth: A large income-tax refund is usually a sign of poor planning. There is simply no good reason to overpay your tax month after month. Instead, putting that money into interest-bearing savings, rather than lending it without interest to the Treasury Department, is a painless way to strengthen your financial future.
Consider Mr. and Mrs. Average Taxpayer. Last year, they were excited about getting their tax-year 2009 refund of $2,887. If this couple, instead of over-withholding by $240 a month, had saved that money in an account earning just 1.5% interest, they would had savings of $2,900 by the end of last year — and wouldn't have had to wait months for their refund.
Now consider what would happen if the monthly money Mr. and Mrs. Taxpayer set aside continued to grow for 20 years at an average of 4% a year (that may seem high now, but historically that's not an unrealistic average). Those savings will add up to quite a tidy nest egg of just under $90,000! (Note: Interest earnings will be taxable unless the money is saved in a tax-advantaged account like an IRA.)
The bottom line: if you set your tax withholding too high, you are giving up, or at least unnecessarily delaying, a great opportunity to build your savings.
To adjust your tax withholding, simply increase the number of allowances on the W-4 form you give to your employer. Use the withholding calculator on the IRS web site.
The ideal would be to end each year owing no tax and receiving no refund. However, because other things can affect your tax situation over the course of the year (buying a house, the birth of child), this ideal tax withholding level is difficult to achieve.
A more realistic goal is to finish each year owing just a small amount or receiving a small refund. It's usually better to be a tad conservative so you don't under-withhold by too much and wind up owing a penalty.
If you've been using tax over-withholding as a "forced" way to save, set up an auto-deposit system with your bank or employer instead. Transfer those funds directly into to savings, rather than sending them to Uncle Sam. This can also be a great way to fund an IRA.
So, what are you waiting for? Cut your withholding and start maximizing your savings.
August 25, 2010 © Sound Mind Investing
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