Key Takeaways
- It’s common to overwithhold taxes, knowing you’ll receive a refund every year.
- Instead of overwithholding, consider putting that money into your 401(k) each month.
- By doing so, you’ll be implementing dollar-cost averaging.
When you look at an optical illusion, you know that your brain will perceive different images depending on where you stand or the angle at which you view it. Is it a duck or a rabbit? It’s a matter of perspective and what your eye chooses to focus on. Well, with tax day upon us, perspective is a timely subject.
Perhaps your perspective on taxes is to overwithhold, knowing that you’ll get a large refund every year. Many people look forward to getting that refund to use on various things. But consider looking at this from another perspective: instead of overwithholding, only withhold what you need to withhold.
For example, say you received a $2,400 refund because you overwithheld on your federal taxes. Instead of getting this money in a lump sum once a year, why not get $200 every month? Then consider doing something called dollar-cost averaging by putting that $200 into your 401(k).
Dollar-cost averaging is something you already do every pay period, when you put money into your 401(k). What does it mean? Well, with money going into your 401(k) on a consistent basis, it means that you’re buying at really good prices when the market is low and buying at not-so-good prices when the market is high. Studies show that, over and over again, this is an effective way to build wealth over time.
You’re not trying to outsmart the market, thinking you can figure out when to put money into it. Instead, you’re doing it consistently over time, regardless of how the market is doing. As an added benefit, you’re saving on taxes by doing this. That $200 every month is pre-tax money when you put it into your 401(k). And while you won’t get $2,400 back, you’ll still get some money back the following year because your taxable income will be lower. Regardless of your perspective, that’s a pretty good win! Until next time, enjoy.
If you’d like to read more on this topic, here are a few of Gary’s previous posts that you might enjoy:
