What Are Tax Withholdings?

If you knew me, the title of this article would be reason to take pause. However, there are a few things that our government does that are worth taking note of, understanding, and then implementing into our lives. One thing in particular is the way that they tax us.

Withholdings – A fairly recent, extremely brilliant development

Did you know that we used to pay our taxes once a year at “tax time?” Depending on your age, your parents or your grandparents lived in a time when there was no such thing as taxes being withheld from your paycheck. Then, as a way to finance the war, the government began asking us to send in estimated tax payments (as part of our patriotic duty). People weren’t too keen on the idea. So the government began to offer incentives for doing so. Eventually the incentives became enticing enough that many were lured into the trap. And from there we slid down the slope to where we are now – being charged penalties and interest for not paying as we go!

So, why is this so brilliant?

How often do you take note of the amount of taxes that were taken out of your paycheck? Could you tell me, without looking, what that dollar amount is? Could you tell me, without doing the math, what that amount adds up to per year? Unless you are in the small minority you probably don’t have any idea. That, right there, is part of the genius of the plan. (That “small” amount of money is taken out of your paycheck before you ever see it, think about it, touch it or wonder what you might be able to do with it if you didn’t have to pay taxes.) The vast majority of people never even notice that it is gone. All that matters to them is the net amount in their wallet.


I can’t tell you how many people I have spoken to that tell me they don’t pay any taxes. It is hard for me not to laugh. Many love the fact that they get most or even “all” of their money back from the government. For them it is like a highly anticipated bonus that comes once a year and they can’t wait to find out how much they are going to “get.” This is like thinking you are getting a great deal from your credit card company who gives you 3% cash back (while charging you 12% and the store you bought from 2%). Who is getting the great deal?

Few are the people that actually get all of their money back. The largest tax that most people pay is FICA (Social Security and Medicare). Do you realize that you pay 15.3% of your earnings for this tax, which is separate from any income tax that you are liable for? Now, if you are self-employed you are probably painfully aware of this fact. If you are an employee you might think it is only 7.65%, if you have done the math. This is the subject for another entry, but let me leave it at the fact that 7.65% shows up as a withholding on your pay stub and the remaining 7.65% (to make a total of 15.3%) is not shown on the stub because the employer takes it out when deciding how much you will get paid and then pays it to the government. You don’t get this money back because it doesn’t even figure into you income tax liabilities (in most cases).

So Am I Just Venting Or Is There A Point To All Of This?

The point of this is that nearly all of us go along in life, planning our budgets based on the net amount of money that we earn after taxes. We usually don’t even think about the money that we paid in taxes because we can’t get it back. So we think of it as a cost of living, or of working, really. If taxes go up we might feel a little frustrated, but then we forget about it and move forward. We make life work regardless of the amount coming out of our checks. This is the brilliance of tax withholdings. We just don’t notice how much we are really paying and we move forward without thinking about it. I truly believe that if everyone had to write a check once per year for the full amount of taxes that they owe (Income, FICA, FUTA, SUTA, Sales, Property, etc.) that there would very quickly be a revolt and the tax laws would change very fast.

And herein lies the lesson: The government has figured out the best was to get us to put away 10-50% of our money without giving it a lot of thought. Why don’t we use the same psychology on ourselves when it comes to saving? If we truly have our own best interests in mind we should set up an automatic “withholding” plan from every paycheck that we earn to save for the future. Automatic savings plans are the best way that I have ever seen for people to put away a good amount of money.

The similarities between taxes and automatic savings are striking. When I talk to people about starting to put away a set amount every month they often wince. Even those who are already doing it and seeing the success of the plan wince when I talk to them about increasing the amount. This is the same reaction that people have when taxes go up and their withholdings increase. In both cases they wince, wonder how they can do it, and then they move on and forget all about it! I can’t tell you how many times I have heard people say “I don’t even notice that it is missing.” And, like taxes, when someone has to write a check for their investments once a year it is a much harder, and often impossible thing for them to do. The government is really good at getting our money from us. We should follow suit in gettingey from ourselves as well.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.