If you get a big rush every year when you find out you are about to get a couple thousand dollars back from the government with your tax return, you are not alone. Not by a long shot.
According to the Internal Revenue Service, the average American makes the error of getting a tax return in the amount of approximately $2,400 a year… Error? What? Well, what a big refund means, unfortunately, is that you have been allowing your employer to take too much money out of your check for taxes all year long.
Do you like giving the government an interest-free loan with your tax withholdings every year? How long have you been doing this, since high school? What about the government giving you an interest free loan – not. What could that couple of thousand dollars a year do for your pocketbook or wallet if you invested it?
Adjust Your Tax Withholdings Now on Your W-4
It is essential that you do the math and figure out how much money you are really supposed to have withheld from your check each pay period. To do this you will need to grab your tax return from last year, your latest pay stub, and load the IRS’s withholding tax calculator into your web browser. Once at the IRS’s site, go through the few steps to figure out what your exemptions and withholding information should be. Be sure to print out the final screen and then take it to your company’s payroll department (you can go ahead and tell them you figured this out at home over the weekend). When they get what you give them, they can print you up a brand-new W-4.
You will notice an immediate and positive impact on your paychecks. So, what now? It’s imperative that you really do put this money to work (for you or someone/something else you care about), so here are a few ideas to consider.
Pay off Credit Card Debt
This is the first thing you should do with that money. If you were thinking about how much good that money could do you earning 8% a year in a mutual fund you are heading in the right direction. But, before you invest that money you ought to consider paying off your credit card debt first. Think about it, credit cards that cost you 14.99% APR on borrowed money versus getting 8% in interest. If you don't pay down some of your debt, 6 out of 10 Americans have something like $8,000 in credit card debt, you'll be going going backwards.
Save Money for Retirement
If your credit cards are all paid off (liar!), pump as much as you can into your employer's 401(k) plan by upping that payroll deduction. If your employer matches contributions, this is an even smarter move. Remember that all your contributions are also tax deductible, so in theory you could move all of newfound income into your retirement plan and actually still be getting more take-home pay than you were in the days of the gaudy tax return. No 401 (k) at your company? Try a Roth IRA and then a traditional IRA. Contact a local financial planner to discuss what is your best strategy.
Make Extra Payments to My Mortgage
If you have a $200,000, 30-year fixed-rate mortgage at 6%, you'd shell out about $230,000 in interest alone over those years. Yikes. If you can find a way to pay an extra $200 a month, that could save you over a quarter of the interest. Worth considering, eh? See the discussion on GetPreQualified.com on other mortgage acceleration payment plans.
Give Some Money to a Charity
If you now have an additional $200 a month coming in, you’ve just won the lottery. There are plenty of hard-working people in the world who don’t see that much money in a month, believe it or not. You can make a huge difference by donating that portion of your income to a worthwhile charity -- and if you itemize your tax return, your contributions will actually reduce your taxable income.
Still think that giant tax return is a gift? Think again!
Josh Michaels is a freelance writer who survives on very little income and carefully considered financial decisions. This combination has allowed him to have fun, travel the world, and start a retirement account – all without the pleasure of holding a full-time job. He can be reached at: joshmichaelsmoney@hotmail.com
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