For many Americans, tax season means looking forward to a refund when they file their taxes. If you're one of the filers that will be getting money back, I have some good and bad news for you.
First, the bad news. A tax refund represents money you overpaid throughout the year, so it's basically an interest-free loan to Uncle Sam. Instead of overpaying and receiving a refund, you can use the
IRS Form W-4 to adjust your tax withholding and keep more of your money throughout the year.*
The good news is that getting a tax refund offers you an opportunity to make some smart financial decisions. The average tax refund was around $2,800 in 2012, so many people receive enough to make a huge positive impact on their financial situation.
Here are a few smart options to use your tax refund.
Option 1. Pay off debt.
Paying off debt is the first thing to consider doing with your refund since dedicating a lump sum toward your debt is a great way to get started down the road to eliminating it completely. A low interest mortgage or student loan is one thing, but what about a high interest credit card or other loan?
Paying off high interest debt is an excellent financial move. Any extra dollar you put toward a debt will save you that percentage of interest over the next year. For example, if you have a credit card with an 18% interest rate, you'd essentially be earning an 18% return on every dollar you put toward that debt since you’d avoid that interest.
Option 2: Build your emergency fund.
Most people know that you should have from 3 to 6 months in a cash reserve, but not everyone has a reserve. A tax refund could be used to start a reserve if you don’t already have one, or use it to replenish your cash reserve if you’ve used some of the funds over the past year. You can check
www.DepositAccounts.com or
www.BankRate.com to find a no-fee, high-interest savings or money market account to use for your emergency fund.
Option 3: Fund an Individual Retirement Account (IRA).
You have until April 15th to make an IRA contribution for 2012, but if you miss that deadline you can still get a head start on 2013. Funding an IRA is a great way to prepare for retirement, and you can choose between Traditional IRAs that give you a tax deduction now or Roth IRAs that can provide tax-free income in retirement.
The maximum contribution for 2012 is $5,000, or $6,000 over 50, as long as you had at least this amount of earned income for the year. Both contribution limits are $500 higher for 2013, for a total of $5,500 and $6,500 respectively.
Option 4: Fund your college savings.
It’s often difficult to juggle saving for retirement with other financial goals like preparing for your children’s college education expenses. Using a tax refund as a lump sum contribution toward college savings can be a great way to save money for college without adding an extra monthly bill. You can go to
www.savingforcollege.com to learn more about the different types of college savings plans.
*Be sure to consult your tax preparer for help determining your tax withholding. The IRS doesn't like it when you underpay!
To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com.
