Best 5 ways to use your Tax Refund!
It’s that time of year again, where the holiday season officially begins for some and ends for others; TAX season.
Whether you receive a large tax refund every year or owe Uncle Sam more of your hard-earned money, it’s best to implement a financial plan to either put the refund to good use, or prevent Uncle Sam from taking as much money from you as possible. While the dealerships are increasing inventory, credit card companies promising 0% balance transfers, malls/shopping plazas advertising blowout sales, and cellphone/tech companies offering “buy one, get one free” deals for the family, we should do the complete opposite what is expected of us; not participate. To help guide you in the right direction, I created a short list of the 5 best moves to make with your money for this year’s Tax season!
- Pay off Debt- It is no surprise that this strategy was included in my list as one of the top ways to use your Tax refund. Paying off debt increases your take home pay and ability to pay off other debts. This also opens the opportunity to invest for Retirement, College Savings for your children, Emergency savings, and best of all, reduce stress. With Student loan, credit cards, and auto loan debt on the rise, many of us have become so comfortable with debt, that as a result, more Americans are living “Paycheck to paycheck”.
Paying off debt with your tax refund is a powerful investment because of the guaranteed returns. Unlike investing in the stock market, when you pay off debt, you are saving on the interest you would have paid carrying the loan to full term. For example, paying off a credit card with a $10,000 balance and 15% interest will save you the entire 15% or $1500. So, don’t buy a $1000 iPhone that will be -100% gain, pay off your debt first, and guarantee yourself a ROI (Return on investment)!
- Emergency fund- According to USAToday, 7 out of 10 Americans lack $1000 in savings. The consequences of not having sufficient savings are detrimental to you and your family. A sudden job loss, family emergency, illness, and many other scenarios could occur causing stress, more debt, and in many cases, a domino effect of other problems that may arise.
If you receive a large tax refund, let that be the jump start to your emergency fund. Most financial experts recommend anywhere from 3 to 6 months’ worth of savings. As a financial coach, I recommend to my clients 3 to 24 months depending on their personal situation. Whether your number is 3 months or 24 months, simply setting up your emergency fund will alleviate future stress and financial issues!
“The importance of having a down payment is critical if you plan to purchase a home in the near future. ”
3. Retirement- If you are in a sound financial situation with little to no debt and emergency fund in place, you should consider contributing to your retirement accounts using your Tax refund. Even if you don’t receive a refund, utilizing Tax efficient retirement accounts such as your employer’s 401k plan, IRA, HSA, etc., could reduce your tax bill significantly. The maximum contribution to the 401k accounts increased 2018, from $18,000 to $18,500 and for those over age 55, the maximum contribution is $24,500. IRA’s maximum contributions remain at $5,500 and for those over the age of 55, $6,500. HSA’s for 2018 can be maxed out at $3,450 for self-only, and $6,900 for families.
There are other ways to invest for retirement outside of these accounts, but these are the most common today. If your refund is $5,500, you can throw that amount at your IRA, and will be completely done with your IRA investment for 2018. If you continuously owe taxes to Uncle Sam, maybe you can max out these retirement accounts to defer the taxes you owe until retirement. Overall, the goal is to invest your money today, so that it can take care of you later. That $10,000 car could be costing you $50,000 in the future!
4. Down payment fund for a home- Once you have reduced/eliminated your debt, fully funded your emergency savings, and contributed towards retirement, maybe it’s time to start saving for a home or a down payment to buy one. The importance of having a down payment is critical if you plan to purchase a home in the near future. Some mortgage lenders require 3 months’ worth of cash reserves, a minimum of 3.5% down payment, and a history of good financial habits. I rarely recommend to only put down 3.5% on a home, instead, I advise others to either save a 20% down payment or pay cash for a home. This creates a buffer during economic down turns, reduces risk of losing your home due to a decrease in value, and drops PMI (Private mortgage insurance). If you plan to buy an investment property, most lenders require a minimum of 20-25% down payment.
Stashing away that Tax refund could catapult you towards your first home or investment property purchase, shaving off years of additional saving!
5. Children’s college savings- As mentioned in my previous blog post, funding your child’s college savings could save your little munchkin THOUSANDS of dollars. Many parents receive tax deductions, and refunds due to the number of dependents they have under the age of 18. Instead of spreading the love to your children by purchasing them designer clothes, cellphones, and car; start teaching your kids financial literacy as early as possible. You can achieve this by showing them how you will invest your tax refund and bonuses this year. Reveal to them all of the long-term benefits of delaying your spending now, to invest for the future and let your money multiply on its own.
You can open a 529 college savings plan, ROTH IRA for children that have earned income, or custodial account that will allow your children to own investments now, and take full ownership of them after the legal age of 18. This simple strategy will impact your child’ life significantly, decreasing time needed to save for retirement, avoiding student loans, and achieving financial independence at an earlier age!
A plethora of information was shared in this post, but I am more than confident you will implement at least one of these strategies in your financial plan this year. You can open most brokerage accounts today with as little as $10. Paying off your debt can be done in a few clicks, and will set you free from the financial burden it brings at the end of each month. Covering your children’s college or funding their investments will not only feel great now, but change their lives forever. Whether your tax refund is $100 or $10,000, let’s change the cycle and make healthier financial moves now, so that we can enjoy them in the future!
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