If you’re lucky you will be getting a tax refund check from the Department of the Treasury in the coming weeks. Here are some tips on how best to use your refund to assist you in accomplishing your financial goals:
Don’t Spend Your Refund Before You Receive it: Many tax preparers offer loans against your refund, allowing you to receive your refund at the time you file your taxes (less interest and fees). If at all possible, avoid these loans. By E-filing and direct deposit you can get your refund in around ten days. If you add up the costs of these loans the effective interest rates are astronomical. It doesn’t make financial sense to take out these loans, and waiting for the money to be deposited in your account is a good way to practice delaying gratification. For many of the same reasons, avoid spending your refund by putting charges on a credit card to be paid off with your refund.
Have a Plan: If you don’t have a plan your tax refund is likely to disappear without much to show for it. Psychologists blame the tendency of extra money to disappear on the wealth effect. When we have more money than we are used to we let our guards down and change our spending patterns. If we are not careful we can spend the extra money two or three times before we realize what has happened, putting us in a worse situation than we were in before we received the windfall. The only way to combat this is to have a plan and stick to it.
Don’t Treat Your Tax Refund Differently Than Your Paycheck: Behavioral economists have noted how we treat money we receive from different sources differently, often discounting (or treating as less important) money we receive from sources other than paychecks. This tendency, along with the wealth effect, conspire to lead us to blow our tax refunds on the unimportant. Your tax refund is a return to you of your hard-earned money, and should be treated as such by putting it to use in helping you accomplish your financial goals. One way to combat the tendency to treat tax refunds differently from other money is to put your refund in a checking or savings account and leave it there for several weeks. After some time has passed the tendency to treat it differently from your other money will magically disappear.
Increase Your Retirement Savings: Having a large tax refund is a great opportunity to increase your retirement savings. Hardly any of us save enough, and putting your refund to work in this manner is a great way to jumpstart the process. You have until April 15 of 2013 to contribute money to an IRA and claim the deduction in 2012. If you add an extra $1,000 to an IRA (assuming you haven’t reached your limit for 2012) and you are in the 25 percent marginal federal tax bracket and the 7 percent marginal state tax bracket, your combined state and federal refunds will only decrease by $680 dollars. Essentially the federal and state governments are paying you $320 dollars to contribute to your retirement fund. This is a fantastic way to leverage your tax refund to help you reach your long-term goals. Also consider decreasing your tax withholdings for the current year, while simultaneously increasing your retirement savings. This allows you to save more for retirement on an ongoing basis without reducing take-home pay.
Treat Yourself: Feel free to treat yourself a little with part of your refund. Just make it part of your plan. Money is meant to be enjoyed, and if it is part of your plan you can splurge a little without feeling guilty.
Pay Off Debt: Use some of your refund to pay off debt.
Establish or Add to an Emergency Fund: Having an emergency fund is an important part of any financial plan. An emergency fund keeps little things from becoming emergencies and allows us to follow our budgets and plans when things go wrong, as they surely will.
The possibilities are endless (they always are when it comes to uses for money) and how you use your tax refund is completely up to you. The important things are to have a plan and to put the money to use in accomplishing your financial goals. With a little planning this year’s tax return can become an important part of your financial plan instead of just providing some momentary pleasure.