In a better tax situation? Use it to boost your retirement

If you received a nice refund from your last tax return, the cash injection might have given you quite the high. And for most taxpayers, there is more good news to come in 2018: With the new tax bill, most of us will be paying a lower federal income tax rate than we did previously.

Give yourself a quick “paycheck checkup”

But before getting too carried away, take a few minutes to check whether your employer is deducting the correct amount of taxes under the new legislation. The IRS has a new tax withholding calculator that enables you to do a quick “paycheck checkup” to make sure the IRS is taking roughly the right amount from your paychecks. If they are withholding too much, you’ll need to wait till tax season to get your money back from them (money that could be earning interest for you instead). Personally, I’d rather get a few thousand back in April than owe the IRS—and risk an underpayment penalty. But I realize that I’m effectively granting Uncle Sam an interest-free loan by letting them hold onto my money all year. You can easily prevent this by adjusting your withholding at any time—by handing your employer a new Form W-4, Employee’s Withholding Allowance Certificate.

Use the extra money to boost your financial fitness

Even if you don’t adjust your status, the IRS has updated its withholding tables to account for the new legislation, so most likely you will have already noticed an increase in your take-home pay. What tends to happen when we get a pay bump is that we start to overspend–often without realizing it. Our standard of living simply adjusts itself to our inflated income. Before you fall into that old trap, pinpoint the after-tax dollar difference between your new and old pay—and put that amount towards boosting your financial fitness.
How are you doing with debt? Has your emergency fund been tapped lately? Monitor how you’re doing with your overall budget, spending versus savings: If you’re not maxing out, see if you can put more in. A lot was going on at the beginning of the year and I almost forgot to change the annual contribution rate on my 403(b)—it’s easily done.
You also need to evaluate where you put your retirement contributions, in light of your new tax situation. Your income tax rate may be lower now than it will be in retirement, so you might decide to put more into a Roth IRA—where you take the tax hit now and enjoy tax-free income as a retiree. For my IRA contributions, I used to put half in a traditional and half in a Roth account, hedging my bets, but this year I’m in the position to take more of a tax hit, so I’m putting more into my Roth.
However you decide to take advantage of your new tax status, make sure you’re seizing it as an opportunity to improve your financial health—because none of us can predict how much our income tax will increase again in the future.
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June 26, 2018