Finally Uncle Sam is going to be paying you! That big check you get in the mailbox after April 15 is your fun money, right? Not really! If you’re getting a large refund, you’ve given the Internal Revenue Service an interest-free loan of your money for the previous year – and we’re sure you could have come up with a better use for that money than that.
What should you do to avoid giving the IRS another interest-free loan this year? You may need to increase the number of allowances claimed on your Form W-4 or reduce your estimated tax payments. Or both. But don’t get carried away. Big underpayments will result in a nasty tax bill next year!
Since it’s your money and you want to make the most of it, here are some suggestions on what you can do with the refund to make it meaningful in your financial life.
Set aside a portion of the refund check, perhaps 10 percent, for your own enjoyment. Spend some time planning how you will spend this small windfall, and really enjoy the process. Plan a massage or nip away to a local B&B. Make sure to buy an experience you will always remember or something beautiful or useful.
The rest should be put to work! If you have credit card debt, this tax refund can be just the thing you need to jump start a debt reduction plan. Be sure to pay down the credit card with the highest interest rate first.
If you are not in debt, use your tax refund to set up a cash emergency fund. Emergency funds are an absolute necessity for financial security because they give you funds to fall back on if you become ill or disabled and can’t work, or if you or your spouse lose your job, incur large medical bills, or have an unexpected large bill such as a major car or home repair.
If you already have three to six months of cash stashed in an emergency fund, use the refund to increase your retirement plan contribution at work. Depending on your salary and your company’s policies, you can increase your contribution by the entire refund for one paycheck and then decrease it for the next, or slowly set aside an amount equivalent to the tax refund you received.
If you don’t have a retirement plan at work or you are already contributing the maximum, use your tax refund to contribute to a Roth or traditional IRA. As long as your income is below the limitations ($110,000 if single, $160,000 on a joint return) you can contribute to a Roth IRA. Otherwise, contribute to a traditional IRA or invest in mutual funds.