Written By: Elissa Wurf
February 2018 offers a unique opportunity. Sometime this month, for most companies, the new withholding tables will come into effect for the calculation of federal income tax withheld from paychecks. According to these tables, which were released January 11th by the IRS, most taxpayers will have less money withheld from their paychecks, and thus more take-home pay, starting sometime in February.
For those who are not already contributing the maximum allowable to qualified retirement accounts, this allows the opportunity to painlessly increase the percentage withheld. This will, on the one hand, result in more tax-deferred retirement savings, and on the other, lower income subject to federal and possibly state tax for 2018 (VA yes, PA no). Lower income means lower tax, hence, having your cake (the increased retirement savings) and eating it too (the lower taxes).
Depending on your income and your current withholding to a 401(k) or 403(b) plan, you might be able to contribute extra to your retirement savings without lowering your net paycheck from what it was at the beginning of the year (when the old withholding tables were in effect). Compare a paycheck from the beginning of the year to one after the change occurs to see how much the tax savings is. You will also need to know whether you are having money withheld from your pay on a flat dollar or percentage basis and, if the latter, what the percentage is. You can then use this to estimate the extra amount contributed to retirement by changing the percentage. For example, if your current gross pay per period is $5,000 and you have 10% withheld, that would be $500 per pay to your 401(k). If the difference between your net (take-home) pay before the withholding tables changed and after is $125, you could save an extra 2% ($100 per pay period) and still have an extra $25 per pay period deposited to your bank account—clearly a win/win situation!
Those taxpayers who are already maxing out their retirement contributions can use the same strategy to automatically deposit an additional bit of savings to their individual or joint brokerage accounts.
In order to make this transition seamlessly, it would be best to do it as soon as possible. Once you get used to having the extra take-home pay, you will feel increased withholding as a loss to be avoided, even if you are intellectually aware that you are saving for your own later good. In thought-versus-feelings battles, feelings tend to win. But if you make the change immediately, you will not have time to habituate to the increased paycheck and the change will be easier to make.
One caution: When Treasury Secretary Steve Mnuchin first announced the change in withholding tables on January 11th, he also recommended that taxpayers double-check that their withholding is correct using the IRS withholding calculator (which is currently being revised and will be back online later in February). This calculator can be found at https://www.irs.gov/individuals/irs-withholding-calculator.
The need to double-check the calculations using the online tool stems from the fact that “old” W-4 forms (which you completed on your first day of employment at your job) are still being used and are not in alignment with the new system and thus there may be some possibility of under-withholding, which would mean a big tax bill due in April 2019. The new W-4s will not be out until after February 15th.
But, barring the caution that you are still having enough withheld to avoid a large tax bill and possible penalty next year when your 2018 income tax return is filed, February 2018 provides a golden opportunity to painlessly increase your savings for your long-term goals while still seeing a bit of the extra pay in your paycheck.