"It's the Most Wonderful Time of the Year!"

No, its not Christmas in June, but almost - yesterday I got my annual merit pay increase! Woohoo! Not that I didn't know it was coming - I have been looking forward to it for awhile, but didn't know how much it was going to be - I predicted a 3.25% and it came in just a tad higher at 3.52%. Not bad. All other parts of my compensation stayed the same.

Actually, this time of year makes it a great time to go through your W-4's and make sure you're having the right amount deducted. In fact, this is what I did last year (not only because of the pay raise, but also because of getting married) and I will do it again this year. This year I will have to increase the amount that is withheld from my paycheck. Since the first part of last year I was single, the amount that was withheld was quite a lot higher than it needed to be, so I changed the allowances in my W-4 so that I underpaid on the last half of the year. All told, by adjusting the withholding, I netted a measly $200 refund from the government (which made me ecstatic - no free loans to the government)! This year though, it meant that the first half of the year I have been slightly underpaying my predicted taxes - so that's where at least a portion of my raise is going to be siphoned off to.

Here's my process: First, I use MSN's tax estimator. This is pretty easy since I have quite predictable income and for the most part expenses. Then I take the difference between what I've already paid (should be on your pay stub) and what the estimator says I will owe, and divide that by the number of pay periods left in the year. This is what I fill out in the "Additional Withholding" when I submit my W-4. Just as a note, you are allowed to change the W-4 as often as you need to in order to have the right amount taken out of your paycheck. This system ensures that I don't pay Uncle Sam any more than I have to interest free.

Some people are so bold as to claim enough withholding allowances to not have to have income taxes witheld for 10 months out of the year, and then have the full amount withheld from the last two months. This would effectively allow them to bank the amount normally withheld for several months gaining interest. For example, if a person had an estimated tax bill of $4800, and instead of having $400 witheld from his paycheck every month, deposited it in an account bearing 5.00% APY for 10 months, and then had $2400 taken out of his paycheck the last two months, he would net about $103 from interest. This is an intruiging idea, but seems a little too close for comfort for just $100 or so (depending on your actual tax bill).