FPA member Matt Showley, CFP®
Last Updated: March 26, 2012
Are you expecting a tax refund this spring? There are many ways to put your tax refund to use and depending on the amount of your refund you should consider some of the following options. Unfortunately money doesn’t come with instructions. So before heading out for a shopping spree, consider a more disciplined use for your tax refund.
An easy choice for someone with high-interest debt, such a credit card balance, would be to make a large payment to help reduce future interest charges. Paying down high-interest debt is an immediate return on your money equivalent to your credit card’s interest rate.
Another good idea would be to establish an emergency fund, which can be useful after a sudden loss of income due to illness or losing a job. With an emergency fund in place you can avoid going into debt because of an unexpected home repair or when you need to pay an insurance deductible. If your emergency fund is already established, then set aside cash reserves above and beyond the emergency fund to help you plan a big vacation or prepare for your next auto purchase.
For long-term planning, consider making a contribution to a retirement account, such as an Individual Retirement Account (IRA). Check with your financial planner or tax preparer to determine the retirement accounts for which you are eligible. Contributions may be tax deductible and you should take advantage of the opportunity for tax-deferred growth that will be important for your retirement.
For the do-it-yourself enthusiasts, start a project around the house where you have been considering a loan or some other type of financing. Now that you have the cash, avoiding further debt for home improvements should add equity to the value of your home over time.
Consider using the money to complete an estate plan, which is often overlooked and is a crucial element to most financial plans. Another option could be to open or add to a 529 plan for your child or grandchild to assist with their college education. The earlier these accounts are opened and funded, the better.
Prospective home buyers can improve their loan applications by allocating a tax refund towards their down payment. Having a higher down payment on a new home will typically qualify you for a lower mortgage interest rate and make you a more attractive buyer.
You shouldn’t lose site of the age old practice of having fun with a tax refund. If you have each of the above items in place or can’t find another strategy that makes financial sense, then you should consider that gadget you’ve been wanting all year or treat yourself or a loved one to a special occasion. The old saying “everything in moderation” also comes to mind; when in doubt you could always do a little of each strategy.
Looking ahead, one strategy to consider is to adjust your payroll withholdings and avoid receiving a large tax refund next year. Visit www.irs.gov and search for the W-4 Calculator tool to help you maximize your monthly income through proper withholding.
FPA member Matt Showley, CFP®, is a financial planner with Creative Capital Management, Inc. (CCMI) in San Diego, Calif.
