Julie Jason's Your Money: New opportunity to up your 401(k) without cutting your paycheck

By JULIE JASON April 13. 2018 9:06PM


The 2017 tax filing season is coming to a close, so you might believe you can put off thinking about taxes - but not yet.

Remember that W-4 form you filled out at work? "Employee's Withholding Allowance Certificate" is the IRS form that tells your employer's payroll provider how much to withhold from your paycheck.

Drop everything and do it again. Now that new tax rates are effective beginning this year (2018), withholding has to be reviewed. The key figure for planning purposes is line 5: the number of "allowances" you're "claiming."

The tax laws that went into effect this year offer advantages to some taxpayers that can either increase your take-home pay or, more important from my perspective, increase your ability to fund your 401(k) plan at work.

"Under the new tax reform law, the majority of taxpayers are seeing lower tax rates of about 1 percent to 3 percent, which can mean bigger paychecks," explained CPA Lisa Greene-Lewis of Intuit.

To some, a bigger paycheck means more to spend. To me, a bigger paycheck means more money to secure your retirement, and here's the big deal: You might be able to contribute to your 401(k) without cutting back your paycheck.

Figuring out whether you can benefit is made a lot easier with an Intuit tool that I'd like to share with you. The tool was created for general purposes, but I'll show you how to use it for 401(k) contributions.

To tell the story, I need to run through some numbers, which I will do using a free tool called the Turbo Tax W-4 Calculator (https://turbotax.intuit.com/tax-tools/calculators/w4/).

Let's assume you do not participate in your 401(k) plan at work because you don't have the extra money to do so. Let's also assume that your company match is dollar for dollar. Now let's work through a few different withholding scenarios using the tool.

While the tool gives you the chance to enter details that will be relevant to your tax situation, such as educational expenses, home expenses, charitable donations and retirement, let's focus on two simple inputs. Under "Personal Info," you'll enter your filing status (single, in this example). Enter your next paycheck as starting on 1/1/2018. Under "Your Pay," enter "Weekly" for your pay period, and under taxable income per pay period, enter "$1,000."

Let's assume you have a "0" allowance. Under "Your Paycheck," enter "0," then go to "Results." You'll see that you will receive a refund of $1,807, and your current withholding is $126, so your net take-home pay will be $874.

Now you can compare different allowances on the same page. For "1" allowance, you'll get a refund of $871. For "2" allowances, you'll have to pay a balance of $13 at tax time.

Let's see the difference in your take-home pay. If you start with 0 and change to 1, each paycheck will be $18 more (current withholding is $108 instead of $126). If you start with 0 allowances and change to 2, each paycheck will be $35 more ($91 instead of $126).

Using the tool allows you to determine your take-home pay by modeling different allowances. More important, it sets a baseline for someone who is not participating in a 401(k) at work. Let's focus on changing from a 0 allowance to a 1 allowance to see the effect of a 5 percent contribution (salary deferral) to your 401(k).

To model that, you would contribute 5 percent of $1,000 a week to your 401(k) ($50 a week, or $2,600 for the year). Can you do that without lowering your paycheck? Go back to wages and reduce your $1,000 weekly figure by 5 percent ($50) to $950: enter "$950" as your pay. Now go to "Results." You'll see that with 0 allowances, you will receive a $1,679 refund.

What does this all mean? When you participate in your company 401(k), the amount that leaves your paycheck to contribute to the plan also leaves your W-2 as taxable income. That's why we reduced your pay in the tool by 5 percent. By reducing the taxable wages in that way, you're saving taxes.

And in this particular example, you're still getting a refund ($1,679), and your take-home pay is $835 ($950 less $115).

If you start with 0 allowances and change to 2, your paycheck will be $868 ($950 less $82). Let's compare that to the first example, where you are not participating in the 401(k) - take-home pay with 0 allowances was $874, a difference of only $6.

So, by enrolling in your 401(k) and changing your withholding from 0 to 2, you have maintained your take-home pay (only a $6 difference). But, most important, you now have $2,600 in your 401(k) that you contributed. Plus, since your plan has a dollar-for-dollar match, you have another $2,600 (subject to vesting schedules), for a total of $5,200. At tax time, you will owe $37.

If your 401(k) has no match, you're ahead by $2,600, since you weren't participating and now you are. If your plan has a dollar-for-dollar match, you're ahead by $5,200 - at virtually no reduction in paycheck.

If you are not participating in your 401(k) at work because you think you can't afford to, check out your withholding.

For a copy of 2018 Form W-4, go to https://www.irs.gov/pub/irs-pdf/fw4.pdf.

Julie Jason, JD, LLM, a personal money manager at Jackson, Grant of Stamford, Conn., and award-winning author, welcomes questions and comments to readers@juliejason.com.


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