10 smart things to do with your tax refund.
Never say the government doesn’t give you anything.
If previous years are any indication, the Internal Revenue Service this year will return $305 billion to U.S. taxpayers seeking refunds. That’s enough money to buy the nation of Chile and its 2,600 miles of beachfront property.
What will you do with your tax refund? There are plenty of ideas. To narrow it down, we’ve combed the universe for the best ideas and consulted with STCU’s financial education officers to list 10 smart things to do with your refund:
1. Spend 10 percent
Let’s be honest: Eventually you’ll make a purchase justified by the memory of that fat tax refund. Better to get it out of your system now and designate 10 percent of your refund for something fun. Then use the rest to improve your financial life.
2. Start or rebuild your emergency fund
Don’t believe an unexpected expense is ever going to happen? Ha, ha! You crack us up!
The best time to start an emergency fund is when you: 1) Don’t have an emergency; and 2) Have the funds to set it up.
By establishing your emergency fund now, you’ll be spared from having to use an expensive credit card or to beg a rich relative for money.
Start with as little as $500, then set up automatic deposit or transfer each month to build the fund over time. Make your initial emergency fund goal achievable, say, one month’s salary, says STCU Community Development Officer Keith Appleton. “If you get a pay raise, increase your contribution accordingly.”
Appleton says a smart long-term goal for the fund is the equivalent of six months’ salary, or enough to survive if you’re out of work for an extended time. Avoid raiding the fund or it will never grow. Repairing the furnace to keep your family warm is an emergency; buying a trolling motor just because it’s on sale is not.
3. Pay off credit cards and other painful debt
Payday loans and high-priced cards issued by stores and others are trying to make money off your misfortune and can bury you in debt. It doesn’t do you — or our local economy — any good if you are forced to live paycheck to paycheck.
Here’s a simple example of why paying off a high-priced credit card with your tax refund can be a boon to your financial life:
If you have a $1,200 balance on a 19% APR department store credit card, it would take you seven years — and up to $2,200 total! — to pay it off by making the minimum monthly payment only. But if you pay off that balance now with your tax refund, you would save $1,000 in interest and be freed from the monthly payments.
4. Save for retirement
Retirement may seem like a long way off, but eventually it will happen. Put a portion of your refund into an Individual Retirement Account while you have the funds to do it.
Depending on your annual earnings, you can contribute up to $5,500 to an IRA for 2014 ($6,500 if 50 or older) and the same for 2015. Choose from a traditional IRA, which defers taxes on your contributions until retirement age, or a Roth, which is funded by your after-tax contributions, but defers taxes on your earnings generated until retirement age.
Another option, for those who have not yet made the maximum contribution to their 401(k) or similar retirement plans at work, is to contribute your tax refund to the plan, reducing your taxable income in the coming year. Consult with your tax preparer or financial adviser.
5. Brace for “higher” education
With tuition rising 150 percent — or six times the rate of U.S. inflation! — since 2003, Washington’s public university system put a new spin on the term “higher” education for consumers. That’s one reason why you might consider using your tax refund to purchase tuition credits, or set up a tax-deferred education savings plan, for you or your children.
For the money it takes to take the family to the movies, you can open a 529 education plan. Prepaid plans, such as Washington’s Guaranteed Education Tuition (GET), allow you to buy tuition credits at today’s price to use in the future. Other 529 savings plan let you invest your savings, with earnings growing tax free toward education expenses in the future.
6. Prepay your next holiday
There’s nothing quite like the freedom of a paid vacation or holiday. Whether you’re off to Hawaii or home for the holidays, consider depositing some or all of your tax refund into a designated savings account for your next big vacation. Add a little extra each week to grow it into a tidy sum and soon you’ll have enough to buy nice gifts for everyone… or to say “yes” when the kids beg to go whale watching, visit an amusement park, or snowboard.
7. Refinance your home
Mortgage rates continue at historic lows, so consider using your tax refund to pay the closing costs and fees necessary to refinance your home. By reducing the interest rate you pay on your mortgage, you may lower your monthly payment or pay off your home loan faster. The change could save you thousands of dollars in interest charges or help to pay off your home.
8. Fill the gaps of health and other insurance
If you are covered by a high-deductible health plan, you could use your tax refund to fund a savings account called a health savings account, available at some banks, brokerage firms, or employers. It pays for medical costs not covered by insurance and your contributions may be tax deductible next year. Consult your tax preparer or financial adviser.
For those who skimp on home and auto liability insurance to save money, you might consider using a portion of your tax refund to buy a personal umbrella insurance policy that pays legal and medical bills if someone is hurt in your home or by your car. For a few hundred dollars, you can purchase $1 million in liability coverage — and some peace of mind for the coming year.
9. Give to your favorite cause
If your financial obligations are covered, this might be the right time to help someone else. Charitable contributions are deductible for those who itemize their tax returns, and it can feel good to support a cause you believe in.
10. Adjust your withholding
What could be better than a fat check from the IRS next spring? How about a hike in your take-home pay right now!
The IRS pays no interest on all that money you’re letting Uncle Sam “save” for you. Ask your human resources department at work for help reducing the amount withheld from your paycheck by filling out a new W-4 form.
Then, make a plan for how to wisely use the “new” money you’ll be taking home each month. Contribute to your 401(k) retirement plan — particularly if your employer matches your contributions — or set aside money each month for any of the suggestions described above.
It’s your money
Repair leaky pipes, car engines, and major appliances before they break. Launch your new business, and more.
There are as many “smart” things to do with your tax refund as there are taxpayers. What’s best for you is something only you and your tax adviser can ultimately determine. The important thing is that you make a plan and stick to it before some unexpected expense or other distraction happens. In time, you’ll be glad you planned ahead.