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For many, tax time means one important thing: a tax refund.
In 2018, the average tax refund was $2,888. According to the IRS, 112 million tax refunds totaling over $323 billion were issued last year.
So, how should you spend your tax refund?
Here are the 5 best ways to spend your tax refund.
1. Stop getting a tax refund
What? Who doesn’t want a tax refund?
You don’t need a tax refund. It feels exciting to get one, but that tax refund is costing you money. A tax refund means you overpaid your income taxes. It’s called the time value of money: a dollar today is worth more than a dollar tomorrow. When you overpay your taxes, it means that you gave a free loan to the government and never got paid for it. Think of your tax refund as the government simply giving you your money back – without paying you any interest.
Make this the last year you receive your tax refund. This way, you can have that money in your pocket during each pay period to save, spend or invest. Contact your human resources department and update your tax forms to reflect your anticipated tax rate and deductions.
2. Start an emergency fund
This is so important. An emergency can strike when you least expect it. Unemployment. An unforeseen medical expense. A surprise home repair. Please don’t get caught off guard.
Start an emergency fund with at least six to nine months (or more) of cash to cover expenses. Use your tax refund to start an emergency fund, or you can add to an existing one. If possible, keep this cash in a separate bank account and don’t touch it unless there’s an emergency.
3. Pay down your credit card balance
Use your tax refund to tackle credit card debt.
You can make a one-time, lump-sum payment to pay off your credit card debt. Contact your credit card issuer to inform them to apply the payment to reduce principal. Without this instruction, your payment might be applied to your next monthly payment, which will cost your more interest.
You also could consolidate your credit card debt with a personal loan that has a lower interest rate than your existing credit card interest rate.
4. Fund A Roth IRA
What is a Roth IRA? A Roth IRA is an individual retirement account that you can fund with after-tax money. Unlike a Traditional IRA, the funds in a Roth IRA grow tax-free since they are taxed upfront.
For the 2019 tax year, if you are younger than 50 years old, you can contribute $6,000 per year. If you are 50 or older, you can contribute $7,000 per year. You can only contribute to a Roth IRA if your adjusted gross income is less than $137,000 for single filers and $203,000 for married couples (although phase outs begin for income at $122,000 and $193,000, respectively). If you withdraw any funds from your Roth IRA after age 59 1/2, they are yours to keep without paying any taxes. Also, unlike a Traditional IRA, you are not required to make mandatory withdrawals from a Roth IRA at age 70 1/2. You can open a Roth IRA with most brokerage firms. You have until Tax Day each year to fund your Roth IRA.
5. Make An Extra Student Loan Payment
One of the best strategies to pay off student loans faster is to make an extra student loan payment. Since there are no prepayment penalties on your student loans, you can use your tax refund to make a one-time, lump-sum student loan payment.
This student loan calculator shows your how much money you can save when you make a one-time payment on your student loans.
Contact your student loan servicer in writing and explain that you want to make a one-time, lump sum student loan payment toward your student loan principal (not to next month’s regular monthly payment).
These 5 strategies may not be your favorite ways to spend your tax refund, but they’re the smart path to financial freedom.
March 6, 2019 at 08:58AM
Forbes – Entrepreneurs