Tax season is over now, and the majority of Americans have already received their refunds. Now that you have this extra cash at your disposal, you have a new dilemma. Should I go on a nice vacation? Buy a new car? Spend it all on debt? There are so many options to choose from, but we want to go with the smart options for your budget and personal finance situation!
How should I use my Tax Refund?
1. Pay Down Debt
If you have debt that you have accrued over the past year (credit cards, collections, past due bills), knock these out IMMEDIATELY! Credit card debt is typically the highest interest debt that most Americans are holding onto. The interest rates may vary between 10-20% for most card holders. Why not get rid of this debt which is helping you stay in debt for longer? The average American, depending on whose statistics you use, is between $5,000 and $15,000. Why not knock out a nice chunk of debt with your Tax Refund, versus spending it on things that you "want". You will end up saving more money in the long run from all of the accrued interest you will end up paying. If you don't have any of the above issues...
2. Emergency Fund
Once your high interest debts are under control, you need to make sure you have sufficient money saved for a rainy day. In fact 90 rainy days is preferred! As mentioned in a previous post touching on Emergency Funds, having enough savings to cover 3 months of expenses is ideal. So if you don't have a sufficient emergency fund, use your refund to add to or complete it!
3. Save Money for a Downpayment
Thinking of making a big purchase some time soon? If so, why not use your refund to help with the downpayment of your future home, or a car you may need. Now don't go get a brand new car because you just want a new car! Especially if there are other concerns, as mentioned above. However, if you rely on your car to get to work in order to make money, then making sure you have reliable transportation is a big priority. In regards to a downpayment for a home, putting more money down will help to reduce the amount of interest you pay over the lifetime of your mortgage. If you have enough saved for a 20% downpayment, this will eliminate any need for Private Mortgage Insurance (PMI) payments in addition to your mortgage.
These are just the top options to use your refund for. Maybe you don't have any of these things to worry about, and you can afford to spend your money on a vacation...that's awesome! But what if you could have your refund money all throughout the year, instead of waiting until next year to get YOUR money back?
Why you Should LOWER or ELIMINATE your tax refund!
8 out of 10 Americans receive a tax refund each year. This means there's an 80% chance that the person reading this blog (YOU) received a refund this year. Not only that, but according to the IRS, the average refund for Americans is over $3,000! So if you typically receive a refund each year, and your income does not or has not changed drastically from year to year, why not receive this money throughout the year instead of waiting on a refund? With a tax refund, you're basically giving Uncle Sam a free loan from the day you pay your taxes, up to the day you receive your refund. When is the last time someone gave you a loan without interest?
As a rule of thumb, most individuals should claim at least one allowance per household member (your roommate doesn't count!). So if you're single, claiming 1 allowance is safe, claiming 2 would put you right at the point of not owing, receiving a very small refund, or maybe owing a little tax at the end of the year to Uncle Sam. If you're married, claim 2. Married with one child, claim......you get the picture!
Lets see some examples of how lowering your tax refund will help you, and why it is important. Lets imagine you have a savings account which pays gives you 1% APR, and a credit card which charges you an APR of 20%. You typically receive a $3,600 refund each year, and you also have $3,600 in credit card debt. If you didn't pay your debt for the entire year, and waited for your tax refund to pay it off, this debt increases to about $4,400. That's an additional $800, not considering minimum payments made, or any possible late payment fees. This is just how much interest can potentially accrue without adding to the debt with new purchases. In the hole $800!
Now using an example of saving $3,600, a $300 each month due to the increase in your paychecks, in a savings account with a 1% APR, you would make almost $20 in that year! Yayyyy!!!! Ok, it's not a lot of money gained in this puny savings account, but what if you were able to invest this money and gain 5% ($99), or 10% ($201) instead. Now this makes a big difference. You know what makes a bigger difference?
What you would save in interest from the credit card debt if you used your extra $300 a month to pay down the debt! Paying $300 monthly would allow you to pay off this debt in 13.5 months. That's just about as long as it will take you to wait on a refund for next year! This would also cut the interest you pay to your credit card company in HALF! About $400 in interest savings versus the $800 more you would have owed with this extra $300 you're now receiving monthly. Think about this, especially if you're an individual that receives much more than the average each year. Could you use an extra $300 or more each month? Extra money to spend on the things that you need, so you won't even NEED to go into debt throughout the year. This of course means absolutely nothing if you don't use the extra money wisely. Creating a budget of your expenses is key to helping you make wise money decisions! What would you do with an extra $300 or more in income each month? Maybe these funds could go to your 401K, IRA or HSA account.
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Akeem The Dream
I enjoy discussing and learning about technology, stocks, sports, and beating my wife at Dominoes! As I learn, I love to share with family and friends so that we can share our knowledge. Thanks for being apart of the journey!