Congratulations! If you just graduated from college, there’s a good chance that you’ll make more money in 2008 then you did in 2007.
You: That’s what they tell me.
In fact, you’ll also make quite a bit more money in 2009 than 2008.
You: How do you know that? You know my raise?
Nope, but in all likelihood, you’ll work less than eight months full-time in 2008. In 2009, you’ll work the whole year. So even if you don’t get a raise at all, your income should dramatically increase from 2007 to 2008 and again from 2008 to 2009.
You: That’s cool, I guess. But where’s the opportunity?
You: Sounds boring.
You: Okay. Go ahead, bore me.
Last week, I told you how to determine how little you can withhold without owing the IRS any interest or penalties. If you are a recent graduate who will make dramatically more each year than the previous, you have a major opportunity to increase your net pay right from the outset.
You: Increase my net pay? Maybe this isn’t as boring as I thought.
You don’t want a big income tax refund, right?
You: Right. I don’t. We covered why an income tax is a bad idea earlier.
If you just complete Form W-4 without any thought, you’ll probably put in “1″ for the number of allowances (line 5). As a result, you’ll wind up with a big refund, since the amount withheld each paycheck assumes that you’ll earn your salary for 12 months. Since you’ll only earn that salary for a few months of 2008, too much tax will be withheld. That’s the first reason why you’ll want to increase your allowances to lower your withholdings.
You: Is there a second reason?
<Think game show voice-over man speaking:> In fact there is!
<Back to normal voice, whatever you might think that is:>
Since you only need to withhold the amount of your prior year’s tax (virtually nothing in 2007 if you were a full-time student), you can even further increase your allowances and thereby dramatically reduce your withholdings.
Increasing your net pay in this manner will allow you to get more money in your hands when you need it most, thanks to the start-up expenses of life including a security deposit, work clothes, and initial emergency fund savings. Just make sure you have enough around next April to pay the piper (should you actually owe the IRS). You can use this handy withholding calculator to help you calculate your allowances (designed to make it so that you neither owe much or get a big refund) or you can spend four days and use the one available at this site.
Figuring this all out is worth it. Personally, I put 10 allowances my first two years of working after graduate school, and still got refunds each year. Not as big as they would have been without adjusting my withholding, but having that money in my initial paychecks to use as needed definitely allowed me to save far more far earlier in my career than I otherwise would have been able to.
Start saving right away by being fiscally responsible. There’s never a better time to develop good, smart financial habits than today.
Let me know what you think and how this works out for you. . .