I got a big chunk of money and I need to pay a big chunk of taxes. What are my options?
1: wait until next year, get another big chunk and pay the next big chunk at once.
2: do a series of smaller transactions over several months or years.
3: some other way?
There are two ways to pay your taxes. You can pay in large chunks every year, or you can pay in smaller chunks over time.
The second method is called a “payroll deduction.” When you sign up for a bank account, they will ask if you want to set up payroll deductions. If you say yes, then out of each paycheck the company will send money directly to the government on your behalf.
“Deduct” means that the government takes first what it needs and then sends you the rest.
A payroll deduction of $1,000 per month is a good way to save some money and also pay a lot of your taxes at once, but there is a downside. If you have to spend $1,000 on something unexpected during the year that isn’t covered by your paycheck deductions, you’ll have to pull it out of another account–and that might be difficult. So if one of your goals is flexibility, it may be better to pay a little bit less each month using one-time payments or quarterly tax estimates.
I was talking to a friend of mine who is a civil engineer. I was complaining that to pay off my student loans (which I have been doing diligently and will have paid off in eight months) it’s going to take me forever. He said “Well, you could sell a kidney.” This kind of thing comes up in conversation with engineers a lot.
Because I am an idiot, it had never occurred to me. Obviously I was doing it all wrong.
The biggest chunk of my tax bill is due every year on April 15th. That chunk is $9000 or so. If instead I had been making monthly payments of $1250, then each month would be about the size of one of those lump-sum payments that I hate paying so much every year. This is an idea that everyone should steal right away.
It can be a smart financial move to pay more taxes in a given year. Yet few people do it. The reason is that it feels like you’re losing money, even though you’re actually making money.
The main reason it feels like you’re losing money is that when you get your tax bill, it’s for the total amount due for the whole year, whereas when you send in your quarterly payments, they go toward paying off only past-due bills.
When you think about taxes as an investment, though, the timing difference becomes less important. You are still investing, but now you are investing in yourself. Paying more taxes a little at a time all year round means buying pieces of next year’s tax refund all year round.
When it comes in one lump sum, though, most people view the tax refund as their money–money they have loaned to the government and are getting back. That’s almost never true–in fact, most of the time you are essentially being paid by the government to borrow its money. But if your attitude is that a tax refund is free money that isn’t really yours until it appears in your bank account, then paying more taxes throughout the year will always feel like giving away your own money–even though it
If you’re like me, you’re probably paying your taxes in installments. You pay a little bit every few weeks or months, depending on how complicated your tax situation is. In the end, though, it all comes out to the same thing: you pay X% of your gross income.
What I did was simple. I just paid more than X% of my gross income. I paid about X% of my net income, which turned out to be much bigger than X% of my gross income. The difference was that I used money I earned on my investments to pay the extra chunk.
I decided there were two things I wanted to do: pay down my mortgage, and pay off my taxes. I found a way to make it happen with the same transaction.
I sold enough of my mutual funds to pay off the mortgage. I was left with cash in the bank and a mortgage that wasn’t costing me anything.
I then used some of that money to buy a “stackable” CD, which is like a regular CD but instead of paying interest every six months, it pays interest every year. This way I ended up paying taxes over three years instead of one. In this case it was from an online broker called Sharebuilder .
So now I have no mortgage and no taxes for three years! The bank is paying me about 5% interest on the money I borrowed from them, and Uncle Sam is paying me about 1% in return for not having to pay him right away.
For the first time, he was watching as his money evaporated. He had sold $30 in stock a few days earlier and that same day the price dropped by a third. He had $300 left in his account, and he owed the government $181 in taxes. “The account is down to $108,” he wrote to his sister. “I have therefore decided to sell the whole business.”