USA TODAY International Edition
Pad your emergency savings
“It is an often repeated assertion that the average American would be hard-pressed to pay for a $400 emergency,” says Kevin Gahagan, principal of Private Ocean, a financial planning firm in San Rafael, California.
So, put that extra money each month toward a rainy day fund. Aim to save at least six months’ worth of your basic expenses – rent/mortgage, car payments, debt obligations, gas and groceries. Stick the money in a low
risk, liquid account such as a savings account.
Grow your nest egg
If you're set on debt and emergency savings, it's time to think about the future. Dump any extra money from your withholding adjustments right into your 401(k), says Eric Roberge, a certified financial planner in Boston.
“Contributing to your 401(k) will also help keep your taxable income a little bit lower, which could help you avoid having to owe come April,” he says.
Don't have access to a 401(k)? Redirect that money to a Roth IRA or Health Savings Account (HSA) for future medical expenses in retirement.
Invest in your children
You also could consider your children's future by increasing contributions to a 529 education savings plan. An extra $125 a month could be worth over $20,000 over 10 years, Fabbri says. Many states also match contributions for lower-income individuals, so a $35-a-month contribution could be more than $12,000 over the same period, she says.
Save for a big purchase
Sure, you could use your tax refund to pay for that vacation, new TV or home remodel. But just the act of saving throughout the year for a specific goal will help you build financial discipline and give you greater control of your money, says Sean Williams, a certified financial planner in Timonium, Maryland.
“It's a lot more fun planning a vacation when you've been building the fund for it,” he says, “rather than knowing you're having to rely on a credit card or facing the uncertainty of a tax refund.”
How to adjust withholdings
The rule of thumb, from financial planners, is to be within $500 of tax liability. Here's a step-by-step guide from Linda Rogers, a certified financial planner in Memphis.
1. Obtain your last pay stub.
2. Enter your information into the IRS withholding calculator.
3. Use the calculator's recommendations to fill out a new W-4 from your payroll department.
4. Don't forget state withholdings. Make adjustments on the state form.
“Seek professional help if your situation is complex,” says Rogers, “such as if you are self-employed or have rental properties.”