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Tax Sense: Smart Uses for Tax Refunds

March 19, 2012

 

Before you receive your tax refund, take time to plan and consider all the options on how to spend it, especially the less “glamorous” options, said a Texas AgriLife Extension Service family economics specialist.
 
“Whether it’s $300 or $3,000, a tax refund is a welcome bonus, and the way you use that money can make a real impact on your personal and financial well-being,” said Dr. Joyce Cavanagh with AgriLife Extension’s family and consumer sciences in College Station. “If you follow a few basic guidelines and think about the future, you can make the most of how you spend that money.”
 
Cavanagh said three general rules relating to tax refunds are: plan ahead before receiving the refund, devote at least a portion of the refund toward building long-term financial security and to not spend part of the refund on unnecessary fees or loans.
 
“Without a plan, many people use their refund money on the first important or seemingly important thing that comes to mind,” she said. “Planning ahead and involving the family in your planning increases the chances you will identify all the possibilities of what you might do with your refund so you can better prioritize these options and decide which should be at the top of the list.”
 
She said some services offering a “quick refund” are in reality offering a high-cost, high-risk loan, and noted there are many free tax preparation programs available, including the government’s Volunteer Income Tax Assistance program, http://irs.treasury.gov/freetaxprep, and the AARP Tax Aide program, http://www.aarp.org/taxaide.
 
“For relatively easy-to-prepare tax returns, there are often free community service programs in which trained volunteers can assist in preparing your return and filing it electronically for free,” she said. “By using one of these free programs and having your refund check direct-deposited into a checking or savings account, you can often get your refund in seven to 10 days.”
 
She added that people may also opt to automatically split their refund and put part of the funds into a checking account and the rest in a savings account or to purchase a U.S. Savings Bond.
 
“In this case, you would have to complete and attach an IRS Form 8888 to your tax return,” she said.
 
Cavanagh said instead of short-term strategies, such as using the money for a vacation or to buy the latest electronic gadget, it’s better to put the refund directly into savings, use it to pay off debts, hold it for emergencies or use it as the foundation for achieving a long-term financial goal.
 
“One of the best ways to apply your refund is toward paying your regular monthly bills in the event you have fallen behind,” she said. “Most other debts can be prioritized, with the highest-interest-rate debts to be paid off first.”
 
For example, Cavanagh said, a person with a balance of $2,000 on a credit card with an 18 percent interest rate and paying $50 a month will take more than five years to eliminate the debt and pay $1,077 in interest.
 
“However, if you apply $1,000 of your refund toward that debt and then continue to pay $50 a month on the remainder, the bill will then be paid off in only two years and the interest paid will be only $198. That would mean a long-term savings of more than $800 in interest.”
 
Cavanagh said other smart uses for a tax refund might include starting or adding to an emergency fund to pay for unforeseen expenses such as home or auto repairs or medical costs.
 
“In the case of the ultimate emergency, the loss of income, this emergency fund could keep you afloat until you are able to find another source of income,” she said.
 
Refund money may also be set aside to pay larger expected bills, such as vehicle insurance, or put into a retirement account, such as an IRA, she added.
 
“If you have an IRA that has an average annual return of 5 percent, a contribution of $500 annually would yield $34,880 after 30 years,” she said. “And if you build on that annual contribution by adding an additional $25 monthly contribution to that IRA with the same 5 percent average yield, in 30 years this will yield you $55,247.”
 
Cavanagh said there’s nothing wrong with applying a refund toward making a more practical purchase, such as a new car, furniture or a major appliance, as some of these may be essential and others may simply add to the enjoyment of life.
 
“The vital question to ask yourself when prioritizing options in making such decisions is: Am I fulfilling a want or a need?” she said. “After you’ve addressed your long-term financial goals, then you can use part of the refund to purchase those items you feel will improve your day-to-day life.”
 
As a final piece of advice, Cavanagh said that if a tax refund exceeds $1,000, it may be worth considering lowering the amount of withholding to increase the amount of take-home pay each payday.
 
“Those additional dollars can be used to meet monthly expenses and for many people can be the difference in whether or not they make ends meet,” she said. ”To change your withholding, you’ll need to file a new W-4 with your employer.”

 

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RELATED TOPICS: Farm Business, Taxes

 
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COMMENTS (1 Comments)

PullMyFinger - Chappell, NE
Tax refund? Never heard of it.
4:16 PM Mar 19th
 



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