Contribute More to Your 401(k)

Did you know you can do yourself a (double) favor by contributing more to your company’s 401(k)? How? When you opt in and have a portion of your income set aside for the account, it’s done pre-tax. That means you’re lowering your taxable income for the year while putting money aside for your retirement. It’s a win-win.

If you haven’t contributed enough to get a full match from your employer, see if you can at least increase to that amount. That’s extra money that’s free and can go a long way towards your retirement with the power of compound interest.

Take Advantage of Flexible Spending Plans and Health Savings Plans

If your employer offers a Flexible Spending Plan or a Health Savings Plan and you’ve signed up for it, make sure you’re taking full advantage of it. They are considered tax favored plans because your contributions are pre-taxed- this allows you to get reimbursed for medical expenses while lowering your taxable income. Keep good records and all your receipts. Check to make sure you’re not wasting any of your contributions by making sure you have qualifying medical expenses.

While most jobs having open enrollment in the fall, you can still keep track of your medical expenses through out this year so you can plan for the next year.

Adjust Your Withholding on Your Paychecks

Depending on your needs and particular situation, you have some choice with your withholding on your paychecks. If you received a big tax refund last year and expect your finances to remain the same this year, you may elect to adjust your W-4 and have less taken out of your paychecks. That means getting a smaller tax refund next year, but having a small bump in your paychecks through out the year.

If you’re expecting a major event this year such as getting married or becoming parents, then you should consider sitting down with your Human Resources Department to update your withholdings.

Thoughts on Preparing for Taxes

I’d love to hear from you about your taxes and finances. How was this past tax season for you? What plans do you have for the rest of 2013?

1.  Don’t Give Up on Last Year Yet

Even though it’s now 2013, there is still time to make some tax moves that will affect your 2012 taxes. One big move I would suggest if it’s available to you is to make a tax deductible contribution to a Traditional IRA. You have up until April 15th or the date you file your taxes to make a contribution for the previous tax year. This move would put more money in your retirement savings and it would be a big deduction from your income, likely lowering your taxes (or increasing your refund) by a nice amount. An IRA can be opened at a variety of places: discount online brokers, banks, mutual fund companies, etc.

2.  Getting a Tax Refund? File ASAP!

If you’re expecting a refund, make an effort to file your taxes as soon as you can. The sooner you get the money the sooner you can put it to work for you in a saving account, to pay down debt, or to spend on that vacation you’ve been wanting to take. Remember, this is your money, so don’t delay.

3.  Know Your Limits

Thinking about the year ahead I like to plan my savings goals for the year based on the published annual contribution limits set by the IRS on retirement, health, and education savings accounts. Each year these limits typically change, so you’ll want to adjust your automatic savings withdrawals to reflect the new yearly goal. For instance, in 2013, the contribution limit on Roth IRAs is going up to $5,500 for most individuals($6,500 if 50 or older). That’s about 458.33 a month for the next twelve months. Be sure to adjust your contributions to reflect this new year amount.

4.  Adjust Your W-4 Withholding

Another adjustment you should potentially make in the new year is to your employer withholding. Pick up a W-4 form and complete it based on your current situation. Big life changes like having a baby and getting married can have a big impact on your withholding, so be sure to keep your employer informed in the new year. The W-4 is your chance to tell your employer how to withhold for federal taxes.  TurboTax W-4 calculator can help you figure out how much you should withhold from your paycheck.

5.  Resolve to Keep Better Records

Finally, make this year the year when you keep better financial records. This will make your tax filing season much smoother. Keeping better track of your financial and tax situation could have a nice impact to your bottom line in the new year.

W-4 Form

There’s some good news if you’re employed and have taxes taken out of your paycheck automatically. When your income changes in this situation, the taxes taken out will change accordingly. But that doesn’t mean you don’t have anything to worry about. You may still be in a situation where you’re having too much or too little withheld, so now is a good time to check your W-4.

You file form W-4 with your employer and this tells them how many exemptions you want to claim so they can calculate how much should be withheld from your paycheck and sent to the IRS. What you enter on this form will largely determine how much of a refund or how much you owe each April, and most people tend to have more money than necessary withheld, resulting in a tax refund.

You can use the TurboTax W-4 salary calculator.  It will only take a few minutes of your time and it will help you come up with the appropriate number of exemptions so that you can maximize your paycheck without letting the IRS hold on to more of your money throughout the year. While there’s nothing wrong with getting a refund every year, it’s still a good idea to put more money into your pocket every month, which can then be immediately applied to one of your many financial goals without needing to wait for that one refund check each year.

For the Self-Employed

If you’re self-employed and expecting a change in income, you’ve got a little more work to do. Since your taxes probably aren’t automatically withheld from a paycheck, you’re likely relying on paying quarterly estimated taxes. When your income changes, so too does the amount of money you need to send in each quarter. In the event your income goes up and your estimated payments don’t increase to reflect that, it’s possible you could be hit with an underpayment penalty.

While it isn’t an exact science, figuring out how to adjust your quarterly tax payments doesn’t have to be complicated. The easiest thing to do is to simply adjust the tax payments by the same percentage as the change in income. For example, if you’re expecting a 20 percent increase in income, increase your quarterly tax payment by an additional 20 percent. You also need to consider your other tax deductions and credits, but TaxCaster can easily help you estimate if you are taking out enough taxes.

There are obviously many other business items and expenses that can change how much tax is to be paid, but if at first you simply increase or decrease your tax payments in-step with the change in income you’ll be in the ballpark. Once you file your taxes at the end of the year you’ll then have a better idea of what those tax payments need to be going forward and you can fine tune it for the next tax year.

Reasons to Change Your Tax Withholding Status

• Change in Marital Status – If you get married or get a divorce, you should complete a W-4 as soon as possible to reflect the changes.
• Change in the Number of Dependents – If you have a child or take on a dependent, you should change your W-4. Be sure to take note of the special sections for child tax credit and child care expenses.
• Change in Spouse’s Employment Status - If your spouse’s income situation recently changed, then you should revisit the W-4. Be careful when you go from a one-income household to a two-income house hold: you will likely need to make fewer allowances since you will have more combined income. Look for the worksheet on page 2 of the W-4
• Purchased Your First Home – If you purchased a home recently, it likely means that you will have mortgage interest and property taxes. Both of those items usually allow filers to itemize their deductions. If you itemize deductions you can designate the specifics on the W-4 and get a more accurate withholding rate.
• Too Much Refund Last Year – If last year’s refund was too much for your liking, and you would like more of that money in your paycheck every week, then you should adjust your W-4.
• Too Much Payment Last Year - Likewise, if you paid too much at tax time last year, then you may want to adjust your W-4 and take more money our of your paycheck throughout the year.

What is a W-4?

When you first see the Form W-4, it can be confusing. The IRS uses slightly different terminology that most filers aren’t used to seeing. It’s no wonder so many people need the W-4 Form explained. The Form W-4 is the tax form that your employer uses to help them evaluate how much to withhold from your paycheck. It contains basic personal information, along with a series of questions to help you determine the number of allowances you are making. Allowances aren’t exactly the same as deductions or exemptions. Allowances simply represent any reason to take less money from your paycheck for tax purposes. The more allowances you make, the less your employer will take from your paycheck for taxes.

How to Boost Your Bigger Tax Refund

I encourage you to complete the W-4 as accurately as possible, making allowances for yourself, your spouse, and your dependents, among other things. However, some people choose to decrease the amount of allowance they claim on the W-4 (regardless of their actual situation) in order to increase the amount of money that is withheld from their paycheck. Such a move would increase the amount of tax refund you get at the end of the year. There is also a line on the form (Line 6) to request additional withholdings. Complete that if you want even more taken from your paycheck (a good idea for those with miscellaneous income). This is not a good way to account for side business income though. If you have that you should make estimated payments.

How to Withhold a More Accurate Amount

To get the most accurate tax withholding, resulting in $0 owed or due at tax time, you will simply have to answer the allowance questions accurately. There is an excellent withholding calculator available on the IRS website which will help you precisely determine your allowances and help you complete the W-4 to meet your needs.

Keep in mind that if you itemize your tax deductions, you will need to make some accurate estimates about those using the worksheet on page two of the W-4 Form. Likewise, when your spouse goes from no income to earning income, you will need to visit the worksheet on page two of the W-4 to help you make allowances more accurate.

Finally, remember that when your life situation changes throughout the year (you buy a house, have a child, get married, etc.), you will need to complete a W-4 to reflect your new situation. This will keep your withholding in line with your true tax status. You don’t have to wait till the new year rolls around.

If you majored in finance, you may know much of what I’m about to share, for most others, it will give you a good start on understanding a partner you will have for many decades to come, the IRS. Allow me to share four tips with you that will help you get grounded in the little but important details you’ll need to have top-of-mind while getting set up at your new workplace.

1. Get to know your W-4. Allow me to introduce Form W-4. This is the form you will use to adjust the tax (versions exist for both federal and state) your employer will withhold from your paychecks. It’s pretty simple, and it’s what you’ll need to adjust as you move through the next stages of your life, marrying, having children, buying a house, etc. These events would impact how much tax you’ll pay over the course of the year and if you don’t adjust your withholdings via the W4, you might be lending Uncle Sam money and getting no return though the year.

2. Understand your retirement investment options. After the W4, your HR (human resources) contact will ask you to sign up for your 401(k) or 403(b) deductions. Hopefully, you’ll be working for a company that offers a match, as much as a dollar for dollar match of the first 5-10% of your income you deposit. The good news is that any money you put into this account goes in pretax so a dollar to your retirement account may only be 75 cents less in your check.

3. Maybe that last thought went over your head? If so, it’s important to understand your marginal tax rate, the rate you pay on the next dollar of earning or save on that last dollar that went to retirement. The US tax code is progressive. This is not a judgment or approval of our code, it simply means that as your taxable income increases, the amount of tax due on the next dollar of your income is higher at say, $40K than at $20k, and higher still at $100K.

Once you are familiar with how to get from your gross income to your taxable income, including your personal exemption (everybody gets one and it’s $3,650 off the top) and deductions, either itemized or standard ($5,700 single $11,400 filing joint) you will be better prepared to make decisions regarding your finances. You’ll know just how much the mortgage and property tax are really costing you, and when municipal bonds are the better choice.

4. Don’t stop spending like a student. While I still have your attention, a bit of advice and a warning. Until now, you were used to living like a student, don’t flip a switch and spend every dime of your income just because you can. This is the time to start off with good habits, saving 10-15% right off the top. These early dollars you save will have 40 years to grow and you’ll be buying your future self a worry free retirement. Short of a true emergency don’t charge more than you will be able to pay when the bill comes in. Debt is a tool that can be used for good purposes, such as buying a house you’ll live in for a long time, or for purposes not so good, like trying to impress friends or neighbors with a too-big-for-your-budget car.

Even though your formal education may be behind you, you’ll work hard to earn your income and a bit of ongoing interest and reading financial topics will help take control of your financial success. Class of 2010, I wish you well.

What Are Tax Brackets

Here in the United states, we have a progressive tax system. As you earn more money, you have a higher tax rate. The amounts within the tax brackets are adjusted for inflation every year. Congress establishes the tax rates and right now the tax brackets are from 10%-35%.

Some people believe that tax brackets only apply to your income from an employer. That’s not true, it includes income from different sources. Tax brackets are based on your taxable income, which can be very different from your gross income, depending on your deductions and personal exemptions.

When you fill out your W-4, try to make it as accurate as possible so your withdrawals can cover your tax obligations.

How Tax Brackets Work

Some people think if they get a raise at a job or earn enough money that puts them in the next tax bracket, they’ll see a huge increase on their taxes. That’s not the case. Your income is not completely taxed at the new tax bracket you fall in. The additional income from a raise will be taxed at the new rate.

We’ll us an example to explain how the tax brackets work. Suppose you’re filing single and have a total of $39,000 in taxable income for 2009. Here’s how your taxes are calculated with the brackets:

• Your first $8350 will be taxed at 10%.
• From there, from $8351 to $33,950 of your taxable income will be taxed at 15%.
• The rest of your income ($5,050) will be taxed at 25%.

So even though you fall into the 25% tax bracket, you’re not paying 25% on all of your taxable income. You will be effectively taxed at a lower rate.