Among the many decisions Lori needed to make when starting her new job was the amount of federal tax to have deducted from each paycheck. The election is made on an IRS form called a 'Form W-4.' Basically, increasing the number of allowances decreases the tax withheld, meaning you keep more of your paycheck every month (but might owe at tax time), while decreasing the number of allowances increases the amount withheld, which means a smaller paycheck but possibly a bigger refund.
Some people set their allowances somewhat lower than needed as a sort of forced savings plan, so that more tax will be withheld and they'll have a big federal tax refund at the end each year. [Editor: Natasha, our other Boot Camp mom, says she's expecting $9000 this year!] I always recommend against that: I think the better path is following the IRS guidelines so your withholding matches your tax liability. Here's why:
1. You're not earning interest on those funds you have temporarily provided the federal government for the year – instead, you're giving the Feds an interest free loan.
2. The 'forced savings' that this causes generally works well only in the first year. After that, people often adjust personal spending – up – with the anticipated tax refund used to pay down the debt that was incurred. Net result – no savings.
You can use the IRS's withholding tax calculator to figure out your withholding. Just be ready with your W-2 and other documents before you sit down: It'll ask you very specific questions about you (& your husband's, if you're married) income, dependents, flexible spending plans, etc.