If you’re like half of Americans this year, you are more dependent on your tax refund to pay for necessities than you have been in the past. But paying more taxes than necessary shouldn’t be part of your game plan. 

There’s a Goldilocks Rule for tax withholding that many payrolled Americans get wrong. It sounds quite simple: Finding the “just right” amount of tax to withhold from your paycheck—not too much and not too little. The goal is to have your withholding closely match your actual tax liability. 

But if it were simple in practice, you would never get a refund large enough to fund a family vacation or a tax bill so hefty, you’re worried how in the world you’ll pay it.  

The risk in over- or under-paying lies in the subcontext: 

• Withholding too much and getting a significant refund means you’ve essentially lent the government your money interest-free. That’s money that you could have, instead, put to work by investing it, using it to pay down debt, or funding a business or other cause. 
• Withholding too little means you might owe taxes, penalties, and interest once you file. The extra penalties and interest can really add up, and suddenly you owe much more than you should have had to pay (once again, benefiting the government more than yourself). 

If you’re a W-4 employee, check and adjust your withholding regularly to avoid surprises at tax time. At minimum, do this annually (especially if your last return included a significant refund or bill) and after these significant changes:

• Salary changes—If your salary or other income sources have increased or decreased, review your income tax rate. It may have changed as well, which can affect the amount you withhold.  

• Spouse or dependent changes—Did your spouse change jobs? Did a young-adult child graduate or leave school? Did you take on an elderly parent as a dependent? Or did your family experience a birth, death, or other change?
• Other income sources—Do you expect changes to additional income sources like interest, dividends, or retirement income that don’t have withholding? Will you incur losses, medical expenses, or other reasons to claim an itemized deduction? 
• Tax regulations—Changes to tax policies and perhaps even tax rate changes are expected this year. When that happens, be sure to review your withholding strategy. 

Many families or individuals juggle several income streams that include a combination of jobs that require W-4 withholding and other self-employment, investment, or side business income. Some people use the “extra withholding” option on the W-4 to “pre-pay” taxes for these extra income streams, but consider your options carefully. It’s vital to discuss your unique income profile with a tax professional to understand how these income sources could affect your withholding.  

The Goldilocks Rule is a great way to maximize your money. When you get it “just right,” you can hold onto your hard-earned dollars and use them or invest them immediately instead of waiting for the federal government to send your “free loan” back to you. Feel free to contact us with questions.  

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