I remember every first day of work I’ve ever had. That feeling of nervousness and excitement. Knowing that I have a great opportunity in front of me and an opportunity to prove myself for future promotions and career growth. New passwords and logins. Meeting new people. And, oh yeah, paperwork.
I don’t think I know anyone who enjoys the paperwork required to start a new job. You’ve already filled out applications, had interviews, background checks, maybe even a drug test. Now you get to fill out a W-4 and I-9 on your first day. It feels like it never ends!
Your W-4 is a tax form that instructs your employer how much tax to withhold from each paycheck. It is quick to fill out, but the ramifications can be big on your impact, so it is important to fill it out right for your needs.
What is a W-4
The W-4 is the IRS form that instructs your employer how many deductions they should use to withhold taxes from your paycheck. More deductions means lower withholdings. Fewer deductions means higher withholdings. Higher withholdings means a smaller paycheck coming to you on payday.
So why would you ever choose fewer deductions? The withholdings taken from your paycheck are given directly to the government on your behalf as taxes. At the end of the year, when you submit your annual tax filing, the difference between what you owe from your income (your income taxes) and what has been withheld equals the amount you owe or get back as a refund when taxes are due.
If you underpay because your withholding was too low, you will owe the government money come April. If your withholding was too high, you will get a refund check back from the government.
The W-4 form has a basic deduction calculator at the top of the form. You can view the entire form at the IRS website here.
How Should You Fill Out the Form?
In general the guide on the top of the W-4 is a pretty good indicator of how much you should withhold. If you are a single person with one job, you will enter a 2 for the number of withholdings (1 from section A and 1 from section B). If you are the sole income earner with a spouse, you will enter 3. Following the section from A to H will give you a number to best estimate your withholdings.
If you earn any income on the side from a side hustle, like I do, you may choose to lower the number, which will increase your withholdings. I earn enough from my side gigs that I have to take extra from my paycheck or pay a heck of a lot more in taxes at the end of the year. I use zero deductions and still owe a little bit.
If you want a bigger refund at the end of the year, you can be conservative and lower your deductions. If you would rather have a bigger paycheck each pay period and save for tax time each year, you can take higher deductions. But make sure you don’t take too many, because if you do you will be subject to a penalty for underpayment during the year.
Is it Better to Owe Taxes or Get a Big Refund?
Some people think it is better to owe taxes at the end of the year to get a bigger paycheck. Others think it is better to get a refund back when you file your taxes, ideally with free online taxes software. There is no right or wrong answer, but there is a right or wrong answer for you.
When you have a higher withholding, some people consider that to be an interest free loan to the government that is not due until later. If you are excellent at budgeting and saving, you can put the money in a savings account or conservative investment and make a little money before you pay it to Uncle Sam. However, you will probably only make a few dollars a month in interest. To me, that isn’t worth the hassle and effort of saving up a big account to pay the government at the end of the year.
On the flip side, if you keep the higher withholding you are much more likely to get a refund at the end of the year. Which situation would you rather be in? Would you rather owe the government a bunch of money, but have made less than a hundred dollars in interest, or have the government owe you a lump sum and not have that interest.
Financially it might make more sense to have the extra few bucks, but in practice it is much nicer to get a big payment back at the end of the year. I know I would rather make a little less every month and get a check from the government than owe.
The Best Situation – Match Your Withholding to Your Tax Bill
The best possible situation is to have your withholding match your income taxes at the end of the year. If you don’t overpay, and don’t underpay, you will get no refund and owe no taxes. That is the ideal of how the system was built.
However, matching your exact income to your exact taxes is nearly impossible. With bonuses, job changes, side income, two income households, interest from bank accounts, investment gains and losses, home loan interest, education deductions, and one of any number of possible items that can change your taxes, I encourage you to be a little conservative, withhold more from your taxes, and get a check back at the end of the year.
You can update your withholdings anytime. Just fill out a new W-4 and give it to your boss or your company’s payroll department.
If you want a little extra help, check out this withholding calculator from the IRS. It will help you pick just the right number on your tax forms.
How Do You Handle Withholdings?
Do you like to owe at the end of the year or get a big check back? Would you rather pick a high number or a low number for your withholding? Share in the comments.
As always, if you have any questions you can ask in the comments below or send me an email from the contact form.
Get the FREE Personal Profitability Playbook
Earn more, spend thoughtfully, grow your wealth, and live a better life through mindful personal finance.