Current estimates from the nonprofit Tax Foundation are that the average federal tax refund will be up to $1,000 higher than last year. Before you go spending that windfall, take a minute to consider how best to use that money.
Your first option is to apply the refund towards next year’s taxes. But chances are there are better uses for that money than tying it up for another 12 months! Read on…..
Debt Paydown
The greatest use would be to pay down any high-cost outstanding debt. If you have credit card debt, that should be your primary use of your refund. Unless you are on an introductory rate, your credit card debt is probably costing you a pretty penny.
For example, let’s say you have a $10,000 balance on a credit card that charges a 19% APR. If minimum payments are 2% of your balance and you only make those minimum payments, it will take you over 60 years to pay off your balance. If you commit to a fixed $200/month, it will only take you 8 1/3 years.
Either way, that is incredibly expensive debt to maintain. The lesson, of course, is not to carry any credit card debt at all, given its very high cost. If you do have credit card debt, you should pay it off as quickly as possible. In fact, if you have a balance, you should stop reading right now and apply that cash to your credit card balance!
For other debts, it will largely depend on your current interest rate. Many existing mortgages, lines of credit, student loans, and auto loans are at extremely low rates right now. That makes paying them off early less imperative, though paying down debt is never a bad thing. Start with the highest-interest-rate loan and work your way down.
Education Savings
If you have children or grandchildren, consider setting up or adding to a 529 college savings plan, preferably an Indiana 529 CollegeChoice Plan.
These plans are a fantastic way to save for college. The money will grow tax-free and can be withdrawn tax-free for qualifying expenses. Indiana residents get an added bonus of a 20% state tax credit for contributions of up to $7,500 per household. This credit is available every year in which contributions are made to the Indiana Plan.
Retirement Savings
If you have earned income, consider contributing to an IRA or a Roth IRA. The appropriate choice will depend on your tax situation. Yes, retirement planning is not as fun as buying something shiny and new, but it is very important. By putting money into an IRA, you get the benefit of tax-deferred or, in the case of a Roth, tax-free growth. That means more of your money can continue growing for you over time. The younger you are, the longer your money can work for you.
Non-retirement Savings
If you are debt-free, have saved adequately for college, and have maxed out your IRA contributions, you can still use your refund strategically. The key is to move it out of your main bank account. If it is out of your bank account, you are less likely to spend it (either unnecessarily or without noticing).
There are several options available to you. The most conservative option would be to move the money to a savings account that is not easily accessible. It would still be available in an emergency, but accessing the money would require a conscious decision. If you don’t anticipate needing the money in the near term, you could move it to a brokerage account or invest directly with a mutual fund company. With good investment choices, hopefully your money will have grown by the time you need it.
The Splurge
This is not to say that spending some of your refund on yourself is necessarily a bad thing. (Maybe a Curt Cignetti bobblehead, or a Cignetti voodoo doll, depending on your affiliation?) It does help stimulate the economy, and it can make you happy, at least for a time. What’s life without a little fun, right? Just try to keep your overall financial picture in mind. Don’t be blinded by the shiny allure of instant gratification.
Summary
Tempting as it may be to immediately spend a tax refund, your overall financial situation could be improved by instead using that refund to help you meet your long-term goals. It does require a sacrifice, but it will be well worth it in the long run.
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We have helped our clients answer these questions and more. If you want a clear understanding of your financial future, and need help making changes to reach your goals, schedule a consultation and we can get started.
This material has been gathered from sources believed to be reliable, however Bedel Financial Consulting, Inc. cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. To determine which investments or planning strategies may be appropriate for you, consult your financial advisor or other industry professional prior to investing or implementing a planning strategy. This article is provided for informational purposes and is not intended to provide investment, tax or legal advice, and nothing contained in these materials should be taken as such. Investment Advisory services are offered through Bedel Financial Consulting, Inc. Advisory services are only offered where Bedel Financial Consulting, Inc. and its representatives are properly licensed or exempt from licensure. No advice may be rendered unless a client agreement is in place.
