Note: None of this should be taken as legal advice. In addition, life changes, such as raises, promotions, marriage, or kids, may result in a higher or lower taxable income. It’s best to consult a professional to see what is best for your individual situation. See my disclaimer for more information.
In this world nothing can be said to be certain, except death and taxes.
– Benjamin Franklin
I think ole Ben hit the nail on the head with that one. Almost everyone has to pay taxes.
If you really want to rule your money, taking control of your tax situation and keeping that money in your pocket is a great way to do that.
Think about it.
I think everyone would agree that someone who worked hard, was disciplined and saved, and is now retired early is a person in control of their money.
But how did they get there? They more than likely invested a lot of their money to the point where it was growing quickly for them, i.e. not in a measly 0.1% interest rate savings account.
Well, what is happening to the money that you overpay in taxes while anxiously awaiting our refund from the government?
Literally nothing. It isn’t growing, it isn’t working for you and it sure as heck isn’t being ruled by anyone.
It is out of your control.
The goal is for you to not only owe the government nothing but that your refund is small too.
You want to be as close to $0 as possible. But for some, that’s a hard pill to swallow.
Many of us really enjoy getting a tax refund every year. Who doesn’t like to get a $1,000, $2,000, $3,000 or more check in the mail every year? Feels good!
It may not be the best for you, though.
I Get it
I understand that some of you may like getting a large tax return. Believe me, I get it. I used to be the same way.
By now, I’m sure you’ve heard all of the normal reasons why you shouldn’t be getting a big tax return such as:
- You’re giving the government an interest-free loan
- The government will never be as good with your money as you are
- Why wouldn’t you want that money in your paycheck?
These may not speak you.
What should speak to you is that whenever this happens, you are not in control of your money. You are not ruling your money.
I’ve had the same feelings before. You may think it’s an easy way to save that money every year or put it towards something worthwhile. It may be a way to pay for a vacation when you otherwise wouldn’t have the money. Besides, it just feels good to get that check.
But did you know there’s a different way to do this exact same thing while still keeping the money under your control?
Automatic Savings Transfers
Automatic savings transfers give you the best of both worlds. You won’t be able to use the money for anything because it would feel like it isn’t even on your check. But it’ll still be yours, earning you interest along the way.
For this to work best, you should open a savings account specifically for this money where it will be difficult for you to touch it. If you’re disciplined enough, you can keep this in the same bank where you currently have your checking account.
To keep yourself from getting to it, try opening a savings account at a separate bank or at an online bank.
Hopefully, I’ve got your attention.
The only thing you won’t get is that big check, but you’ll have an even bigger chunk-a-change in your savings account from earning interest throughout the year.
For this to work, though, you’ll need to figure out how much to adjust your tax withholdings to get that money back on your paycheck and transfer out to your savings account.
Luckily, I’ve got all you need right here.
Let’s get started!
Step 1: Figure Out Your Current Tax Withholdings
Start by finding your payroll information on your most recent check stub. Some things that you’ll want to look for are:
- Federal Withholding dollar amount
- Social Security dollar amount
- Medicare dollar amount
- State Tax dollar amount (Unless you’re one of the seven States that doesn’t collect income tax)
- Any type of post or pretax deduction dollar amounts such as healthcare premiums, 401K contributions, etc.
You’ll also need to know how many dependents you claimed on your W-4 form when you were first hired. For a lot of people, this will be zero. If you don’t remember, you can always ask your payroll department or manager what they have on file.
Step 2: Head to Paycheckcity
Navigate to paycheckcity.com and enter your current payroll information. Your payroll information will be on your most recent check stub.
On the homepage, you’ll be presented with a row of options that look like this.
Select the salary calculator if you are salaried or hourly calculator if you get paid by the hour (I know…captain obvious over here).
The only difference between the two is that the hourly calculator adds an extra section called “Rates Information.” You put in your hourly rate in this section and it calculates your gross pay in the “General Information” section rather than manually entering your gross pay like in the salary calculator.
By selecting one of the two paycheck calculators you’ll be presented with a screen that looks more or less like this.
The date isn’t going to matter for our purposes so go ahead and start by selecting the state you live in. After you select your state, continue by adding your salary or hourly information.
For salary, enter in your gross pay, make sure gross pay type is set to annually, and select your pay frequency.
For hourly, you’ll have that extra “Rates Information” section to be able to enter your hourly rate. This will auto-populate the Gross Pay field—rather than needing to manually add your gross pay—and defaults to the gross pay per pay period. This is fine unless you want to see how much you make a year.
You’ll want to enter the number of hours you usually work in your standard pay period. So if you get paid every two weeks and always work 80 hours in that two week period, you’ll want to put “80” in the Hours #1 field.
On to Your Tax Information!
After entering your pay information, select your filing status, the number of federal allowances you currently claim, and if you have any additional withholdings or are exempt from any. For example, my filing status is Married and I currently claim 3 allowances on my federal taxes. I have no additional withholdings and am not exempt from any taxes.
Next, enter your state information. Depending on your state, this section will look a little different. Illinois looks like this.
After you enter your state info you’ll come to the “Voluntary Deductions” section. This is where you enter in your medical premiums and deductions, 401K or Roth IRA deductions, things like public transportation monthly passes, or anything else that is taken out of your check.
There are buttons to add or remove deductions if you need to do so. Don’t forget to change the drop down from percentage to fixed amount for deductions that are set dollar amounts like medical premiums.
Depending on the deduction, you may be exempt from none or all of these. Here are some examples:
- Roth retirement accounts – These are not exempt from any taxes
- Traditional 401Ks – exempt from Federal taxes, taxes in some states, but not FICA
- Healthcare premiums – exempt from everything
I highly recommend comparing what Paycheckcity gives you to what your actual pay stub looks like after putting in your deductions. They will be almost an exact match and it’s a great way to make sure you’ve checked all the right boxes.
Also, if you have any of the exempt deductions taken out post-tax (as in, they are being taxed), it might be worth checking to see if your employer can start taking them out as pre-tax deductions.
After you are done with your deductions—or determine you don’t have any right now—select the “Calculate” button at the bottom.
When the paycheck information loads, it should match your current paycheck (it may be off by a few pennies in some tax categories).
If it isn’t, go back to the calculator, double check everything, and fix what might be wrong.
This step is where the fun begins and you start to see how much more money you can get on your check!
Note: When you hit the back button to go back and adjust your amounts, the deduction information does not stick. The drop-down changes—such as changing from percent of gross to a fixed dollar amount—should remain. However, you’ll need to re-enter in your deduction name and amount.
For this part, you’ll need to know how much your tax refund was this year for both state and federal. Let’s start with federal.
Figuring Out What to Change for Federal
What you want to do here is divide your federal tax refund amount by the number of paychecks you receive in a year. Here are some examples:
- If you get paid weekly, divide your tax refund by 52
- Divide by 26 if you get paid every other week (26 times a year)
- Divide by 24 if you get paid twice a month (24 times a year)
Now that you’ve got that number, the goal is to gain as close to this amount on each paycheck as you can without going over. Going over means you would owe the government something. We don’t want that either.
As an example, if you received a $1200 tax refund and get paid 24 times a year, you’re going to want to adjust your holdings so you get as close as you can to $50 added back to each paycheck without exceeding that amount.
For this part, we’re going to be concentrating on the “General Information” section, specifically the field titled “# of Federal Allowances.” Unless your refund was $2,000 or $3,000, it’s best to start small with the changes in your deductions.
Hit the back button—or open a new browser tab—and add 1 to your federal allowances. So if you are claiming 0 in that field, you’ll change it to 1. If you’re claiming 1, change it to 2, etc.
Double check to make sure your deductions are correct again and then hit the “Calculate” button.
Is the additional amount on your paycheck close to the amount we got when dividing your refund by the number of times you get paid without going over?
If it is, then you’re done! Woohoo!
If not, let’s try upping the number a bit.
Hit the back button again and add to the number of federal allowances by two or three, depending on how far off your paycheck amount was from your goal. Repeat this until you are close to your amount but not over it.
If you try a federal allowance of 3 and it is over the dollar amount you are shooting for, then you know that you can claim a federal allowance of 2 and not any more than that.
Write this new federal allowance down somewhere so you remember it. Also, write down how much you are gaining on your check. This is the amount that you will be automatically transferring to saving.
Adjusting State Withholdings
Repeat the same process for state withholdings.
- Divide your state refund by the number of times you get paid
- Start small and make changes to the “State and Local Information” section
- Figure out how many allowances you can claim to get as close to the monthly version of your state refund number
- Write down the new number of allowances you’ll claim
- Write down the amount your check has increased by so you set up an automatic transfer to your savings account
If you live in Alaska, Florida, Nevada, South Dakota, Texas, Washington, or Wyoming, you won’t even have to worry about this section. Due to those seven states not having state income tax, this section will be completely blank.
For Illinois, I focus on the basic allowances. I claim 2 for those. Your state may vary on what field you should be looking at.
As soon as you figure out what you can claim for allowances on your state income tax, write this number down with your federal allowance.
Again, write down the dollar amount of the change to your state tax on your check. We’ll add this to the amount we’re already going to be transferring automatically to savings from federal.
Now, that we have all of that out of the way, you can make these changes with your employer.
Again, be advised that your tax situation may change mid-year, and it’s always best to consult a professional before making changes. I felt pretty confident in the changes I needed to make so I went ahead and changed them with my employer.
You will more than likely have to fill out a new W-4 for your federal insurance. Some companies let you make changes electronically to federal.
My company allows me to change federal electronically, but for state, I have to fill out a new form. Your mileage may vary.
After filling out the new forms, determine when this will take effect. Depending on your companies payroll system, it could take effect the very next paycheck or take two or three pay periods to update.
Set Up Automatic Transfers
The reason for determining when these changes will affect your paycheck is so you know when to start the automatic transfers!
Setting up an auto transfer for this new money on your paycheck will have the twofold effect of still feeling like you are not seeing the money as well as allowing you to earn some interest on your money.
Depending on your company, you may be able to set up automatic direct deposits into more than just your checking account. My company allows me to send to my checking account and up to 3 other accounts. I have the option to automatically transfer from my check to a savings account so the money literally never hits my checking account.
This is the most ideal situation.
If your employer can only direct deposit your check into your checking account—or does not offer direct deposit—you can still set up recurring bank transfers from your checking account to your savings account both inside and out of your bank
Consult your bank for more information.
The Best of Both Worlds
That’s it! Now you’ve got the best of both worlds!
Many people like to get a tax refund and I completely understand why. It’s a financial adrenaline shot to the arm when you get a big check.
When you get that check, you can all of a sudden pay off a bunch of debt or go on a nice vacation. You may use it to bolster your emergency fund or investment accounts and feel like you have more discipline to use it how it’s intended if you get it all at one time.
The only problem is that this money is out of your control when it’s in the government’s hands. That money is not doing anything for you.
Adjusting your tax withholdings and then setting up automatic transfers to remove that money from your check without you seeing it is the best of both worlds.
You get to keep your money in your hands, but you also get the same feeling of not having that money because it’s removed from your checking account. Give it a try! I promise you won’t regret it.
Anything to add? Comment below!
Editor’s Note: This post was originally published in April 2017 and has been completely updated for accuracy and comprehensiveness.