Are You Overpaying by $250 per Month?

Would you knowingly overpay one of your bills by $250 every month? Most people would say, “No, of course not.” Yet, that’s what can happen when taxpayers have too much money withheld from their income for taxes.

Withholding is the process that deducts money out of your paycheck or other income each month. The money goes to your federal and state government who happily hold on to it until you file your tax return. If you had too much money withheld the government returns the amount you overpaid in the form of a tax refund, but does not have to pay you a single penny for keeping your money all year.

If there’s one nugget you can give your kids about tax refunds, it’s this: “A tax refund is not a gift. The government is not giving you money. The government is simply returning your money because you paid too much.”

Most kids might then ask, “Then why pay the extra money in the first place? Why not keep it for yourself?” Good question.

If you are one of those taxpayers getting the average refund of around $3000, here’s one example of how that $250 a month could make a big difference during the year.

Suppose you have a credit card with a $3000 balance and paid only the minimum payment each month. It would take you 29 years to pay off the $3000 and would cost you an additional $5329 in interest.

If, instead, you paid $250 per month if would take just over a year to pay off and cost you only $290 in interest. Anything you can do to reduce or ideally eliminate credit card interest will increase your bottom line. Guaranteed.

Suppose you always pay your credit card bills and never pay interest. Consider putting the money in your retirement savings. An extra $3000 a year will continue to grow until you retire. Another win-win option.

So, when you have the “tax talk” with your kids, explain that a taxpayer has some control of the withholding process. The key is to know what the tax liability is.

Look at your 2010 tax return and find the total tax. This is your tax liability. Knowing your tax liability is important. As long as you continue to have at least 100% of the tax for the previous tax year withheld you will avoid any penalty for underwithholding.

Then, look at the payments section to find the amount you overpaid. This is what determines the size of your refund.

Decide by how much you want to reduce this amount to get your withholding closer to your tax liability. Changing your withholding does require wrangling with Form W-4. The IRS provides a Withholding Calculator and information on making adjustments when there are two income earners.

Remember it’s your money. It may take some effort but you can make changes to your withholding so that you have control of more of your money. Ultimately, this is a good learning example to share with your kids.

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