Here’s Four Alternatives: to stop that and start this…
Many taxpayers say they like having more money withheld for Federal income taxes than needed, so that they’re forced to save. They “cash out” that savings when they get their refund.
Unfortunately, letting the government hold onto your money:
- Means you’re not using it to meet your current financial needs and goals
- You’re letting a disinterested third party hold onto a significant amount of your money
- Results in receiving 0 (zero, zip, nada) interest, so your money doesn’t work for you at all.
- Has no flexibility, if you need the money sooner.
So, Stop That and Start This
Let’s discuss some other options you could do if you were to reduce your over-withholding. (Note: I’m talking about over-withholding–you always need to make sure you withhold enough to pay your taxes!).
- If your employer allows, set up an allotment from your paycheck directly to a savings account. Not enough interest for you (even though it is higher than zero)? Consider a high yield savings account or a CD that allows monthly deposits. Watch out for fees and minimum balances for high yield savings accounts and make sure the CD interest penalty for an early withdrawal won’t be a problem. If you can’t set up an allotment through your employer then you can set up an automatic transfer from your checking account to occur after your paycheck is deposited.
- If you are worried about inflation, one way to address that is to use the automatic deposits to purchase I series US Savings Bonds through Treasury Direct. With the I bonds you get a fixed interest rate plus an inflation rate that is adjusted twice a year. So you get some inflation protection. You don’t make “big money,” but it will be there when you need it – if two disadvantages aren’t a concern. One is that you can’t cash in the bond for the first year you own it. The second is that if you cash it in before 5 years you pay an interest penalty. But I bonds can be great if you need some restrictions to keep you from touching the money, if you have plenty of time before you’ll need the money, and if having the money preserved is more important than “big” gains.
- Boost your 401K or other retirement account contributions. Do this automatically too. For most of us, this is a long term play, but it is never too late to contribute to retirement accounts – IF you are still working. There is a 10% penalty for making non-qualified withdrawals, which usually means you are taking the money out before you are 59.5 years old (although there are some exceptions). It isn’t unusual to get returns of 7 to 10% a year on average in retirement accounts, if invested in a diversified portfolio – much better than the 0% return of letting the IRS give you the money back via a refund.
- Pay off debt faster. Wish you had more room in your budget? Pay off the credit card debt, the personal loan, or car loan. Not only does this give you the benefit of opening up your budget once the debt is paid off, but you also pay less interest so it saves you money. Again, do this automatically so you don’t have to think about it and you at least have to make the effort of a few mouse clicks to spend the money on things you may not really need to spend money on.
Well, that is four and there are many more.
For all of these alternatives, you net more than if you use the IRS to force you to set aside some money. Oh–and you don’t have to worry about IRS delays causing you to get your “savings” late.
Having trouble making the change? We at the Better Financial Counseling Network can help and you can request a free consultation to see how we can help you here.