Adjust Your Tax Withholding With Your Employer, Save Money

Listed below are the amounts of my federal tax refunds from the past two years.

2008 Federal Tax Refund = $2,975
2009 Federal Tax Refund = $2,347

As you can see by looking at these amounts, they are quite high! However, it wasn’t until last Thursday when I posted the amount of my 2009 tax refund on the social networking site,, that I was alerted that the magnitude of these sums was much higher than necessary. Given the magnitude of these taxes, I would no doubt being looking forward to the 2011 payroll tax holiday. Prior to posting on, I figured that these sums were pretty normal for someone that is my age with no children to claim as exceptions.

And, what was more, I learned that I could do something about it fairly easily – just by adjusting the amount of withholding that my employer keeps from my paycheck each month. Since this realization was a fairly significant and interesting find for me, I figured I would commit a post to this topic to share my mistakes with everyone and explain how you can avoid it!

How Much Is My Employer’s Maximum Withholding Costing Me?
So, let’s get started! First, just out of curiosity, I wanted to create a tool to use to capture the amount of money I had lost out on by giving the government an interest free loan instead of investing the money in a way that I found most appropriate.

What I put together can be found at the Google Docs link below. To adjust it to your specific situation, complete the following steps below:

  • Download an Excel version copy of the spreadsheet by clicking File –> Download As –> Excel sheet.
  • Open the file and enter the $ values of your 2008 and 2009 federal tax refunds in the green cells in the upper right hand side of the spreadsheet.
  • The spreadsheet will then automatically calculate (in blue highlighted cells) the amount that you would have made by adjusting your federal tax withholding with your employer in such a way that you don’t get any refund back when tax season rolls around, and investing the difference in an S&P500 index mutual fund.

Google Docs – How Much is Withholding Too Much Tax Costing You?

Entering the tax refunds amounts shown above that I received in 2008 and 2009, I calculated that I would currently have $795.47 more net worth than I currently have, due to the face that I gave the government a very generous interest free loan.

Dang, I really wish I would have known this before! Blast!

How Do You Adjust Your Withholding Preferences?
So, now you’ve realized that you have an opportunity to save some money by having your employer withhold less of your income for federal tax payments, how do you take action to make this a reality?

As it turns out, it is VERY easy to make this adjustment. All you have to do is either a) log-in to your employer’s online payroll management website (if available), click on the Payroll and Compensation tab, and then click on the link labeled, “Federal W-4 Tax Information” or b) call up your Human Resources department, and request that you want to view/adjust your Federal W-4 Tax Information reporting.

Please note: that the exact wording will change, depending on your employer. But as long as you know that the Federal W-4 Tax Information is what you want to adjust, you’ll find your way!

Once you have accessed the correct system (whether online or through the phone), you will then look for the field where you can adjust the total number of allowances you are claiming.

If you’re like me, you are probably wondering, “What exactly is an allowance?” Essentially, a withholding allowance is used by your employer when tabulating the amount of income tax to be withheld from each paycheck you receive. The range of withholding allowances you can choose is from 0 up to a maximum of 10. The more allowances you have, less money will be withheld for taxes. For most people, this is the same number of personal exemptions they are planning to claim on their taxes.

So, for example – if you are married and filing jointly, you would claim 2 allowances. If you are single, you would claim 1 exemption. Get the pattern?

What Amount of Withholding Is Right For Me? How Many Allowances Should I Claim?
As a general rule of thumb, a personal should claim the same amount of allowances as the number of exemptions they are claiming on their federal taxes.

However, since this is the My Money Blog, where we go all out to save every dime we can, we will use online calculators to figure out what number of allowances we should be claiming so that we do not overpay on our taxes.

The two best withholding calculators I could find online can be accessed using the links below. To use them, click on the links, print off a copy of your current paycheck with all of the deductions for taxes and insurance premiums, and fill out the required fields in the calculators.

IRS Withholding Calculator
HRBlock – Tax Withholding Calculator

Using the calculators above, I saw the following results –

Using the HRBlock Calculator, it computed that I should be claiming 10 allowances (the maximum). While this may seem pretty crazy, it may actually make sense because I will be taking a 67% paycut when I attend graduate school full time this fall. However, I am a little cautious to follow this since the HRBlock calculator does not take in to consideration the wages that I will receive while working as a graduate student this fall.

The verbatum results from the IRS Withholding Calculator are as follows. “Based on the information you previously entered, your anticipated income tax for 2010 is $1,885. If you do not change your current withholding arrangement, you will have $7,020 withheld for 2010, resulting in an overpayment of $5,135 when you file your return. If you want your withholding to more closely match your anticipated tax, adjust your withholding on a new Form W-4 as follows:

  • For the only job you entered (which has a projected salary of $XXXXX): 6 allowances.
  • Check the “Single” box on your Form W-4.

Assuming these recommended allowance(s) are in effect for the rest of 2010, your expected refund should be about $600. Following this recommendation will ensure that the amount withheld from your wages will cover all of your projected tax liability while minimizing your refund.”

So, looks like 6 allowances is the number that I am changing my claimed allowances to! 🙂 I tend to trust this number more because the IRS Calculator gave me the opportunity to enter my salary that I will be earning throughout the entire year.

And, do you want to know the great thing? Since I have already paid enough taxes this year for the 6 allowance level, I will not have any federal income tax withheld from my paychecks after making this change!

Do You Ever Have to Pay Penalties For Not Having Enough Taxes Withheld?
Before I jump in and increase my number of withholding sixfold from 0 to 6, I want to also know if I will be penalized for doing this by the IRS. In other words, I want an answer to the question, “Will I be penalized if I underpay the IRS for decreasing my withholding?”

According to the article at the link below, the IRS penalizes taxpayers who have to pay more than 10% of their tax when they file their annual tax return. So, theoretically, since the IRS calculator states that I will still have a refund of $600 for 2010, I should be all right and not get penalized.

Penalties for Not Having Enough Tax Withheld

When Would It Be a Good Thing to Get a Big Refund Back?
Since I am a fairly effective saver of money, having larger than necessary amounts of money withheld from my paycheck is not needed, in my opinion.

However, I do believe claiming fewer allowances than needed is good for people that have trouble saving money because it acts as a forced savings program (similar to the way paying for a home mortgage is, by nature, a forced savings plan).

I hope this post was insightful and that it helps you on the road to financial success. Please let me know if you have any questions.

Keep on learning!


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