The Importance of Reviewing Your Tax Withholdings Before Year-End

As the year comes to a close, reviewing your tax withholdings is one of the most crucial steps you can take to ensure your finances are in good shape. Many taxpayers overlook this task, but adjusting your withholdings can prevent an unexpected tax bill or ensure you’re not giving the government an interest-free loan. Whether your goal is to maximize your refund or avoid a surprise tax bill, evaluating your withholdings before the year ends is a smart financial move.

Here’s why reviewing your tax withholdings is important and how you can make adjustments to align with your financial goals.

1. Avoid an Unexpected Tax Bill

One of the most significant reasons to review your tax withholdings is to avoid an unexpected tax bill when you file your return. If not enough taxes were withheld from your paycheck throughout the year, you could find yourself owing a substantial amount come tax time.

Why It Happens:

• Change in income: If your income increased during the year—perhaps due to a raise, bonus, or new job—your current withholdings may not be sufficient to cover the additional taxes owed on that higher income.
• Life changes: Events like getting married, having a child, or buying a home can affect your tax situation and the amount you owe. If your withholding hasn’t been adjusted to reflect these changes, you may owe more than expected.
• Multiple jobs: If you or your spouse has more than one job, your combined incomes might push you into a higher tax bracket, resulting in under-withholding if both employers are withholding taxes based on separate lower-income brackets.

By reviewing your withholdings before the year ends, you can adjust them to better reflect your current financial situation and avoid an unwelcome surprise in April.

2. Maximize Your Take-Home Pay

On the flip side, if you’ve been withholding too much throughout the year, you might be giving the government an interest-free loan. Many taxpayers receive large refunds each year, but that refund represents money that could have been in your pocket throughout the year.

How to Maximize Take-Home Pay:

• Review your refund history: If you’ve received large refunds in previous years, you might be withholding more than necessary. Adjusting your withholdings can increase your take-home pay without waiting for a refund next year.
• Update your W-4 form: You can adjust your withholdings by updating your W-4 form with your employer. By increasing the number of allowances or reducing the amount withheld from each paycheck, you can keep more of your money throughout the year and use it for savings, investments, or day-to-day expenses.

Maximizing your take-home pay allows you to put your money to work for you now rather than waiting for a tax refund.

3. Adjust for Major Life Changes

Major life events can significantly impact your tax liability, so it’s important to review and adjust your withholdings if your situation has changed this year. Without proper adjustments, you could be under- or over-withholding.

Common Life Changes That Affect Taxes:

• Marriage or divorce: If you got married or divorced, your filing status changes, which affects how much tax you owe. You may need to adjust your withholdings to account for the new tax bracket you’re in as a result of your new marital status.
• Having or adopting a child: Adding a dependent to your household typically increases the number of allowances you can claim and may also qualify you for credits like the Child Tax Credit. Adjust your withholdings to reflect these changes.
• Buying a home: If you purchased a home this year, you may now qualify for tax deductions like the mortgage interest deduction. Updating your withholdings can ensure that these deductions are factored into your tax situation.
• Change in income: Whether you got a raise, started a new job, or lost a source of income, a change in your earnings impacts how much tax you owe. Adjust your withholdings accordingly to ensure you’re paying the right amount.

By accounting for life changes, you can make sure your withholdings match your new tax obligations and avoid financial surprises.

4. Align with Your Financial Goals

Reviewing your tax withholdings is not just about avoiding an underpayment or overpayment—it’s also a way to align your tax strategy with your broader financial goals. Whether you want to increase cash flow for other investments or ensure you’re saving enough for tax time, adjusting your withholdings can help.

Examples of How Withholding Adjustments Support Financial Goals:

• Increase savings: If you’re withholding too much, consider reducing your withholdings and using the extra take-home pay to boost contributions to your retirement accounts (e.g., 401(k), IRA) or increase emergency savings.
• Pay down debt: Extra cash from reduced withholdings can also be used to pay off high-interest debt faster, saving you money on interest payments in the long run.
• Plan for major expenses: If you anticipate major expenses next year (e.g., a home renovation, vacation, or education costs), adjusting your withholdings now can help you save toward those goals while ensuring you don’t owe come tax season.

Aligning your withholdings with your financial goals allows you to take control of your finances and maximize the impact of your hard-earned money.

5. Minimize Penalties for Underpayment

If you don’t withhold enough taxes throughout the year, you could face underpayment penalties when you file your tax return. The IRS requires taxpayers to pay at least 90% of their tax liability throughout the year, either through withholdings or estimated tax payments. If you don’t meet this requirement, you could be hit with penalties and interest.

How to Avoid Penalties:

• Calculate your estimated tax liability: Use the IRS Tax Withholding Estimator to get an accurate estimate of how much you should be withholding based on your income, deductions, and credits.
• Make estimated tax payments: If you’re self-employed or receive substantial income from investments, you may need to make quarterly estimated tax payments in addition to adjusting your withholdings.
• Catch up before year-end: If you discover that you’ve under-withheld during the year, you can make additional payments before the end of the year to avoid penalties. You may also be able to increase your withholdings for the final pay periods of the year to catch up.

Minimizing underpayment penalties ensures you keep more of your money and avoid costly fines when tax season arrives.

6. Plan for Changes in Tax Laws

Tax laws can change year to year, and staying on top of these changes is essential for ensuring that your withholdings are accurate. Adjustments to tax brackets, deductions, and credits can affect your overall tax liability.

Why It’s Important:

• New tax brackets: If the tax brackets have shifted for the year, your tax liability may increase or decrease depending on your income level. Review your withholding to ensure you’re not caught off guard by these changes.
• Expanded credits or deductions: Changes to credits (e.g., Child Tax Credit) or deductions can impact how much tax you owe. For example, if a credit you previously relied on has been reduced or eliminated, you’ll need to adjust your withholdings to avoid underpaying.

Staying informed about tax law changes helps you ensure your withholdings are aligned with current rules and prevents surprises come tax time.

Final Thoughts

Reviewing your tax withholdings before the year ends is an essential part of smart financial planning. Whether you want to avoid an unexpected tax bill, maximize your take-home pay, or align with your financial goals, adjusting your withholdings ensures you’re not paying more—or less—than you should.

Take the time to evaluate your current withholdings and make any necessary adjustments to finish the year on solid financial ground. By doing so, you can enter the new year with confidence, knowing that your taxes are under control