Mr. Refund, meet Mr. 401(k)

by Stephen Butler

"King Kong vs Godzilla" is a cult classic movie of the 1960s.

I was reminded of this film when my column last week on automatic 401(k) enrollment prompted a call from Mike Kolar, a Chicago CPA who has pioneered a seamless electronic tax refund program known as "Mr. Refund" offering a better mousetrap for taxpayers filing electronically.

McDonald's, GM and other large companies as well as the Army have adopted the program, but its use is voluntary on the part of employees.

What Mr. Refund solves is the problem of mistakes or oversights on e-filings. The average excess withholding was $2,237 last year, and that was before we consider state tax refunds or the lost tax savings overlooked in many cases. The cost of this service is $25 per person and is paid by the employer.

Where Mr. Refund intersects with Mr. 401(k) is the point at which an employee reduces his or her tax liability when he or she voluntarily defers income to a retirement account. Few employees, upon signing up for a 401(k) contribution, ever bother to revisit their "exemptive provisions" (IRS jargon for number of claimed dependents) to change their tax withholding amount. Instead, they leave their number of claimed dependents untouched and struggle to get by on the lower take-home pay created by their 401(k) contribution or even low income tax credits.

It takes a lot of self-discipline and foresight to use a 401(k) plan effectively, but what reasonable person would also want to compound their sacrifice by making an interest-free loan to the U.S. government? In fact, 77 percent of all Americans overpay their taxes and get at least some money back.

We have the right to tell our employer how much to withhold. Mortgage payments, actual dependents, charitable contributions, 401(k) contributions, Section 125 contributions and other deductions all combine to reduce what we ultimately owe in taxes.

The number of dependents we may be claiming for withholding purposes has nothing to do with children. It is a calculation determined by how much net income we will have after all deductions are subtracted. We claim the number of dependents that will line up our withholding amount to the amount we will actually owe. Any payroll service or human resource person can help with this calculation.

The average contribution for hourly wage employees is about 6 percent of pay per year, and the average hourly annual income is about $30,000. This puts the average 401(k) contribution at $1,800. If the average excess withholding amount is $2,237, then employees are loaning more to the government than they are depositing into their retirement savings. Of course, we get the excess withholding back, and we all like what amounts to a Christmas club of annual forced savings, but most of us are always struggling with cash flow. We tend to blow the tax refund on whatever, then continue the struggle until the next January.

Like the original "Ghostbusters," Mr. Refund and Mr. 401(k) combine forces to create what we'll call "Tax-busters!" An accurate tax return from Mr. Refund for the previous year will give us an indication of what we will have to pay in the coming year. Then we work with payroll to adjust our withholding to a correctly anticipated amount.

On average, this turns our 401(k) contribution of $1,800 into a $4,037 contribution without reducing our take-home pay by one dime. How can that be?

The average 401(k) of $1,800 plus the average excess withholding of $2,237 equals $4,037. Sure, the government needs money, but it gets enough based on what we actually owe. It doesn't need a short-term interest-free loan that would otherwise be better invested in our 401(k)s. Moreover, we get a further tax deduction for the $2,237 that further reduces the taxes we owe. This is known as simultaneous equation or, in this case, a downward spiral of our tax obligation.

Companies adopting automatic enrollment especially owe it to employees to help with this tax arithmetic to lighten the load and to help employees save as painlessly as possible.

In California, the typical take-home pay cost of a $1,000 contribution is $650. If we recover another $300 of excess withholding, the take-home pay cost of that $1,000 is as low as $350. All this wealth-building created by the stroke of a pen: Who can resist it?

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