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Let’s Talk Taxes

Understanding Withholdings

You just got your paycheck. Your eyes scan down the list of deductions and settle on the most important part—your take-home pay. You take that number and start subtracting your bills, your day-to-day purchases, or that expensive item you’ve got your eye on. However, hiding in the often-overlooked payroll withholdings, you may find some untapped potential.

Paycheck withholdings are a fact of life for most workers, but they aren’t set in stone. While it might seem like the right idea is to accept your withholdings as given and hope for a big refund at tax time, you’re better off taking a more proactive approach. With a closer look at your life situation and a touch of math, you can wind up with more pocket money and better financial well-being.

Manage the Math 

If you want to get your withholdings right, you’ve got to crunch the numbers. Luckily, there are numerous online withholding calculators that you can use to make the process quick and easy. Everyone—from the IRS to banks to tax service providers—has their own version, but the basic concept is the same. Using the figures from recent tax returns and pay stubs, you can calculate your estimated yearly income as well as the resulting withholdings, and then optimize your earnings.

Know Your Withholding Allowances

The key to maximizing your take-home pay is to take full advantage of withholding
allowances. Tax allowances are factored in when your employer calculates how much federal income tax to withhold from your pay. The more allowances you claim, the less money is withheld from each paycheck. Using a W-4 form, you can claim a variety of allowances depending on your marital status, number of dependents, property taxes, federal student loans, child care and more.

Typically, your employer will give you a W-4 form to fill out at the beginning of your
employment, and sometimes each year thereafter. You should make sure any pertinent changes are reflected on an ongoing basis. You can always fill out a new W-4 form yourself when your personal financial situation changes in a way that impacts your tax allowances. Make sure to adjust your W-4 when you get married or divorced, have or adopt a child, get a second job, your spouse gets a job or changes jobs, or if you’ll be unemployed for part of the year.

Although it always seems best to get as much monthly take-home pay as possible, you generally want to use caution, and stay away from claiming too many allowances. If your employer ends up not withholding enough from each paycheck, you may end up with the nasty surprise of a large balance owing when you complete your yearly income tax return. Worse still, you could possibly be subject to penalties that will sting financially.

Watch this video to learn more about withholdings, and how they affect your earnings: