When you, as a full-time employee, fill out a W-4 form that dictates how much money should be withheld from each paycheck for taxes, most experts will advise that you select the exemption number that will get you closest to a zero balance on April 15. In other words, the total amount held from January through December should equal, or be very close to, the tax bill amount revealed in April. If you opt for too many exemptions, you may owe above and beyond what you already paid in withholdings, and you'll have to write a check and possibly pay a penalty. If you select too few exemptions, then you get a big refund, but you relinquished control of that money over the course of the year.
If you opt to obtain more balance of your withholdings versus your tax refunds, you gain the opportunity to do the following:
- Earn interest. You (rather than the IRS) can earn interest on that money. Even when interest rates are low, interest is income. When rates are high, having that cash in an account can make quite a difference.
- Invest. With the extra money in your paycheck, you can make some good investments that can make a significant improvement in your financial future.
- Reduce debt. Do you have a credit card balance? Lowering tax withholdings and retaining more of that paycheck will allow you to start paying down expensive debt.
- Save for rainy days. Put away a little extra money for later.