In the first newsletter we discussed spending traps. Well it’s tax season and if you are receiving or anticipating receiving a tax refund then chances are you are already in a spending trap. In fact you are in the biggest spending trap America has to offer; Refund Season!
What is Refund Season? Well for tax professionals it’s actually Tax Season. That time between January 15 and April 15 when American Tax Payers meet with us to prepare their annual tax filings. But for all too many of our clients it’s that time of year that they look forward to every year to help themselves get back on their financial feet. Many clients receive large tax refunds every year. For some it’s a forced savings. They are not disciplined enough to save during the year so they allow their governments and municipalities to do it for them. They struggle throughout the year trying to make ends meet and for them tax time is a blessing. The reality is that it’s not. Your paycheck can be a blessing to you every payday if you manage it properly, including the number of allowances you take on your W-4. Instead of loaning thousands and thousands of dollars to your government interest free, get your money and use it to pay yourself everyday.
Let’s take a look at a W-4 withholding example. You remember that form don’t you? You filled it out when you first started your job. If you haven’t seen it in a while or don’t remember what’s on it then it’s time to visit your friendly payroll officer. I know, I know. It’s that dingy little office all the way in the basement. Well slap on your Fitbit and take the stairs. It’s time to get back into good financial shape. You might as well burn a few calories in the meantime.
So you’re in the payroll office, now what? Your payroll officer most likely is not going to offer you advice on what to do in determining the number of allowances you should take, nor should they. What they will do is go through the instructions provided with the form to make sure you understand how to complete it. These instructions are important and can be very useful in helping you determine what’s best for you. Take it home with you and read it over. You can also visit IRS.gov for more information on W-4 calculations. The IRS provides a W-4 withholding calculator. This calculator can be used to determine your federal withholding for the current tax year. In order to get started you will need to have the following three things handy; 1. Your most recent pay stubs 2. Your most recent tax return 3. Estimated values for expenses such as education loan interest, charitable donations, alimony, etc. If you need help you can sit down with your tax preparer and run the calculator together. Even if it’s not tax season most tax preparers are available to discuss tax issues throughout the year.
Ok, now let’s get to that W-4 form. I have a client who is married and files a joint return with her husband who is currently unemployed. Their standard deduction is $12,600, for Married Filing Jointly(MFJ). Their standard deduction is always larger than their itemized deductions. Based on an annual salary of just over $56,000, their tax liability for 2015 will be approximately $4500. Currently on her W-4 she is carrying only one allowance. As a result the federal government will deduct an additional $2411 from her paycheck during the course of the year. While this will result in a refund when she files her 2015 income taxes that $2411 that could have gone into investments, savings or to pay off credit card debt. Instead this generous client chooses to loan it to the government interest free. In order to correct the overpayment she should adjust her allowances based on her salary and filing status of Married Filing Jointly to three allowances. This will get her refund closer to $75 meaning that she and her husband will keep more of their hard earned money during the year.
Now that you have this extra money in your paycheck what are you going to do with it? The answer to that question depends on your willingness and ability to become financially free. If you want it then you are going to have to invest that money in your future. Don’t be afraid of the word investing. It simply means to empower with authority. Through investing (empowering) and not consuming (destroying) you are giving yourself authority over your financial future.
Doesn’t it feel good to know that you are in the driver’s seat? You are in control.
In order to remain in control of your finances you must be disciplined in saving and spending. Here are a few steps to help you stay on track and invest that extra money you are now receiving every payday.
Steps to Financial Freedom
1. Prepare a budget that includes the additional income from your paycheck. Be sure to include all sources of income and expenses in your budget. If your budget is not accurate it won’t be useful.
2. Use a portion of the additional funds to pay down high interest rate credit cards or loans.
3. Use the balance of the funds to start saving and investing. The most disciplined way to save is via payroll deduction. You can have funds debited directly from your paycheck and placed into a savings or investment account. Remember these funds are for saving and or investing and not for spending
4. Readjust your spending habits especially during the holiday season. Remember you won’t be receiving a large refund anymore to help you pay off that holiday debt.
5. Stay focused on the ultimate goal of financial freedom. Sure you’ll be tempted to spend but just remember that the more you spend the further away you will be from your goal.
Following these simple steps can really begin to change your life for the better.
Stay focused and remember that you are in control of your future. Give yourself the life you dream of. The power is in your hands. I know you can do it. Keep me posted!
feliciacook 