Now that tax reform has passed, many of us are still wondering “How will this affect me?”. While most Americans will experience a slight “pay increase” due to a lower tax bill, tax reform has affected our take-home pay in varying degrees. Some are having too much withheld from their paychecks, while others are under-withholding and could see a larger-than-expected tax bill next April. How can you know what to expect and what can you do about it?
As you’re likely aware, your withholdings are a result of how you fill out your W-4 with your employer. Your employer then uses a withholdings table (most employers switched over to the updated IRS tables in February) to calculate how much to withhold from your paycheck based on your income and your W-4. The more allowances you claim on your W-4, the less they will withhold from your paycheck.
You can claim anywhere from 0 (which will almost always result in a refund unless you have other taxable income) to 99 allowances (claiming 99 allowances will result in no tax withholdings). Beyond the number of allowances, you can list an additional dollar amount you want withheld from each paycheck for Federal taxes. So if you want to dictate the exact amount you want withheld per paycheck, you could claim 99 allowances and then write in the dollar amount you want withheld. I’d only recommend this if you really know what you’re doing, but it can be an effective way to take control of the withholdings.
The IRS has put together a pretty handy tool to help taxpayers (yes, you read that right!). If you use this calculator, you can enter your overall income and deduction amounts and they will tell you how many allowances to claim and what amount of refund or liability you can expect. When using this calculator, you’ll want to have your most recent paystub and last year’s tax return. With that in hand, you can get a pretty accurate prediction of your tax situation for the year.
If you have a pretty level situation from 2017 as far as income and deductions go, you could still end up with a recommended change to the number of allowances to claim, based on your number of dependents and the changes to the overall tax code. If you don’t change anything, you will likely see a slight decrease in the dollar amount of taxes withheld due to the changes in the withholding tables released earlier this year.
Ultimately, there’s not a right answer as far as how many allowances to claim. That’s because some folks prefer to get a large refund and feel like it’s a “bonus” even though we all know it’s an interest-free loan to the government. Others would prefer to come as close to break-even as possible knowing that they got to control the money and potentially put it to good use throughout the year. Regardless of your preference, no one likes to be surprised with taxes. So get your information and complete the calculator and make an intentional choice.
Since most Americans will be seeing a slight decrease in the amount of taxes owed, and because the withholdings tables are generally withholding less in taxes, this is a great time to increase the amount you are contributing to your 401(k) plan. Most of us are more likely to save if it happens automatically, and rather than having the extra income go to your checking account, I recommend that you increase your retirement savings slightly. If you earn $100,000 per year and you are able to contribute an extra 2% of income to your 401(k), an 8% annual growth rate on those funds over 20 years would result in a net increase of $91,520. If you let this nest egg then grow for another 20 years of retirement, it would result in a balance of $426,590! Thanks Uncle Sam!
If you need some help drilling down, analyzing your tax situation or putting together a plan for further reducing your tax liability, let us know and we’d be glad to help.
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