Here’s my proposal. Beginning in January, I want you to send me an extra $50 or $100 every two weeks until year-end. You can send even more if you wish. In return, I PROMISE, girl scout’s honor, that you’ll get back every nickel in 16 months time. This will make you so happy you’ll splurge on something special—a vacation, perhaps, or some wickedly kick-ass boots. At very least, you’ll pay off some lingering bills that have been hanging over your head. Woo-hoo!

What’s that, you say? Not interested? I can’t imagine why. What I am proposing is the very same strategy that intelligent, financially sophisticated women engage in all the time. I’m talking about over-withholding from your paycheck for income taxes. Pay it in, get it back, interest free. It’s a great way, I’m told, to avoid any nasty shocks where you end up owing the IRS big time.

I’ll be the first to admit that getting an income tax refund is not necessarily the worst financial blunder you can make, particularly now that interest rates on bank savings or money market accounts are so ridiculously low. As such, a tax refund is almost the same as stashing money under your mattress. Almost, but not quite. The mattress strategy still trumps the refund, in that you can get to your money anytime. Try asking the IRS for an advance before April 15.

A Little Budgetary Discipline, Please

My gripe with large tax refunds (or large underpayments for that matter) is two-fold. First, they make mincemeat of any attempt to manage your cash flow. Second, they are often unplanned.

To make a budget work, it is important to match the timing and amount of your income with your expenses. Too many expenses and too little income force us to resort to credit cards or savings, which is why budgets are important in the first place. But it’s virtually impossible to maintain any budgetary discipline when you get last year’s cash for this year’s expenditures, as happens with a refund, or when this year’s money is needed to pay for last year’s expense, as happens when you owe the IRS money. Either way, the amount to be refunded, or the amount to be paid, seems to “escape” the budgetary process and becomes a happy or unpleasant surprise, depending on who has to write the check. As such, we often feel entitled to blow our refund on stuff that we would otherwise never buy, or we scramble to find the funds to pay the IRS.

Know What You Owe

The surprise factor leads to my second gripe: most people have no idea how positive or negative their current account with the IRS is going to be. I have spent many years preparing tax returns for clients, and it was a rare individual who did not call a few days after leaving off the shoebox full of receipts and records to ask, “Am I getting a refund?” If I called them before they called me, they would groan and say, “How bad is it?” Clearly, they had no idea what to expect.

Next to your housing expenses, your income taxes are likely your largest annual expenditure. Planning for that expense—knowing approximately what it is going to be—just makes fiscal sense. It also allows you to develop strategies for reducing that expense. Trying to rustle up deductions or credits for your 2010 tax return in April 2011 works as well as closing barn doors after the horses are out. However, using your 2010 tax return to help you plan for your 2011 tax liability is definitely worth the effort.

What I am recommending is pretty radical: figuring out what your annual tax liability will be, with a small margin for error, early in the calendar year. If you have an accountant, ask him or her to throw in a tax projection while preparing your last year’s return. Most accountants will simply “safe harbor” you by telling you what you need to have withheld or pay via estimates in order to avoid penalties. They generally do not, unless they are asked, tell you what to pay to avoid significant refunds or underpayments.

If you do your own taxes, or use an express tax-prep service that provides only tax compliance rather than tax planning, then it’s up to you to do the projection. Now that Congress has decided to keep 2010 tax rates, deductions, and credits more or less the same for next year, you can use 2010 tax software to run a 2011 projection. You should not need any tax training to run these programs. One of the most popular programs—TurboTax—takes on the persona of a kind and patient uncle as it coaches you through your paces. Promising “easy questions about your life,” it begins the process with the gentle invitation, “Let’s work on your personal info.” If you’re not paying attention, you might think you are talking to your therapist.

Review Income and Expenses Quarterly

What if your finances make a projection early in the year difficult? Perhaps you are self-employed with uncertain revenues, or have significant investment assets that produce variable income depending on the market. All the more reason tax projections are imperative. In fact, they should be prepared and revised periodically as your financial life plays out over the year. You are likely required to make estimated tax payments, so you need to review your income and expenses at least quarterly to pay in the right amounts.

CPAs and financial planners often counsel, “Don’t let the tax tail wag the dog,” when their clients are considering a financial transaction or strategy solely for a tax benefit. What I am recommending, however, is just the opposite. Go ahead and get a good grip on that tax tail—know what you will owe, and take action to bring your withholdings or estimates in line with that estimate. You’ll find in so doing you’ll get a handle on the whole “dog”—your income, your assets, your expenses. In other words, your total financial situation. That in turn leads to a financial awareness that is much larger than just knowing your tax liabilities.

Knowledge is power, and you’ve just taken the first step to a powerful financial future.

About the Author

Eleanor K. H. Blayney, CFP^®, is president of Directions LLC, an online organization dedicated to educating and engaging women in personal finance. She is a licensed Certified Financial Planner and the author of Women's Worth: Finding Your Financial Confidence (2010), which speaks to women about the major financial issues they face, and The Home Budget Workbook (2010), a straightforward guide for creating and maintaining a practical budget. Eleanor is a graduate of Mount Holyoke College and Cambridge University UK, and earned her MBA at the University of Chicago. She belongs to, and has served on the boards of, numerous professional organizations. To learn more about Eleanor, visit herwebsite.

Read more articles by Eleanor Blayney.