One of the only positive aspects of tax season is your refund. We all look forward to a little extra cash. It’s tempting to take that money and splurge – you worked hard for that money, right? But before you head to the mall, or your favorite e-tailer, here are some ways you can get the most from your tax refund.
1. Open an Individual Retirement Account (IRA)*
The greatest advantage to opening an IRA is that you earn tax-free interest: use your money to make more money. IRAs help you gain tax advantages to your investing and can be opened for free. They are great retirement saving tools. Any payments you have made before April 15th give you an entire year’s start.
A Traditional IRA is different from a Roth IRA. No taxes are paid while the money is invested in a traditional IRA until you begin withdrawing money during retirement. Here’s a chart from TRowe Price to understand the differences.
Opening an IRA for a child is the perfect gift because it gives the money a long time to grow and is an excellent example of the power of starting early and compounding interest.
[Be sure to check out our other articles on IRAs.]
*Do you have an employer sponsored retirement plan: 401(k) or 403(b)? Make sure you are contributing the maximum amount allowed, especially if your employer is matching your contributions. Read more about retirement planning.
2. Pay off credit card debt
Paying just the monthly balance on your credit cards is not savvy. Over time the amount you owe will keep accumulating, bringing the original purchases you made to be more than triple the original cost. You do not build any equity by using credit cards. Paying off your debt will strengthen your credit rating, which then leads to a lower interest rate. Pay off the cards with the highest rates first. Read more about credit card debt.
3. Start or contribute to an Emergency Fund
Financial experts suggest saving between 6-8 months of your monthly expenses in case of an emergency. Think about opening an online savings account. You’ll earn more money by receiving higher interest rates than going to a traditional “brick and mortar” bank. Here’s a review of the best Online Savings Accounts. Read more about the importance of an emergency fund.
4. Pay down some of the principal on your mortgage
Your home mortgage provides a return on investment more reliable than anything the stock market can offer. Yet more than half of your monthly mortgage goes directly into the bank’s pocket; i.e., interest payments. If you pay more than your monthly payments it’s applied directly to your mortgage’s principal balance. Hence, you save a lot of time off your mortgage; i.e., reduce total interest paid. Use this calculator to determine what you will save and gift yourself the peace of mind in knowing you own your home.
5. Reduce or eliminate a refund for next year
Yes, it’s fun to get a refund. However, 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. 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. How much should you withhold?
Get that refund working for you!