Ideally, your tax refund shouldn’t be at a level that makes you want to do a touchdown dance. Large refunds mean the government is getting an interest-free loan from you during the year. Sure, it’s nice to get a lump sum of cash to do something with, especially something fun. Wouldn’t it be better, though, […]
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Ideally, your tax refund shouldn’t be at a level that makes you want to do a touchdown dance. Large refunds mean the government is getting an interest-free loan from you during the year. Sure, it’s nice to get a lump sum of cash to do something with, especially something fun. Wouldn’t it be better, though, if you had use of that cash during the year by having fewer taxes withheld and taking home a bigger paycheck? But, what would you do if you had a bigger paycheck?
Maybe you have the discipline and systems in place to set cash aside from each check instead of spending it. Many people don’t, and look at it as a forced saving strategy. Hey, if that works best for you, great. Personal-finance strategies are as much about what makes financial sense as they are about what actually works for you with your behavioral tendencies. It then becomes a question of what to do with that refund. Consider carving out a portion for something fun and use the rest for something that puts you in a better financial position. Here are some possibilities.
Beef up your emergency fund
Generally, your emergency fund should cover three to six months of living expenses, or higher if you have job insecurity, dependents, or are retired. These cash reserves can cover living expenses should you lose your job, face a health issue, or need to wait out a bad market decline in retirement. The fund also can cover unforeseen expenses such as car repairs, home repairs (i.e., furnace, water heater), medical emergencies, and children-related expenses.
Knock down debt
If you have credit-card balances, use some of the refund money to knock down the balance and save yourself some interest and stress. Some ideas on how to tackle this topic and prioritize by shoring up your emergency fund include getting a handle on everything you owe, looking for a lower interest rate, and developing a spending plan to free up more cash flow.
Put it toward retirement
Retirement can seem so far away (sometimes even if it’s next year), but saving as much as you can, as early as possible, can mean less out of your pocket later due to the power of compounding. Let the money do some of the work for you. If $100 earns a hypothetical average annual return of 8 percent, you would then have $108 earning 8 percent, which then becomes $116.64 earning 8 percent, and so on. The more time you have for that magic to work, the greater your earnings might be and the less cash out of pocket you would need to accumulate a retirement nest egg.
Save for college
If you have determined that you can afford to save for your children’s college education without jeopardizing your retirement security, consider using some of your refund to add to your college savings accounts. A 529 college savings plan is an effective vehicle to use for this purpose. New York state allows a married couple an income-tax deduction of up to $10,000 for contributing to the New York 529 plan and the funds can come out tax-free if used for qualified education expenses in the year incurred.
Improve your home
If there are some home improvements you have been hoping to pursue, your refund could help keep you from having to borrow the money for them. As with everything else, balance this wish-list item with your other goals to make sure everything is properly prioritized. We have seen clients overextend themselves in this area, leaving something else at risk (retirement, for example).
Your refund might feel like found money, but rather than spending it all on something frivolous, now is your chance to do something practical with at least some of it so that you might produce longer-lasting results.
Cynthia (Cindi) Turoski, CPA, CFP, is a managing member of Bonadio Wealth Advisors, LLC, and has more than 25 years of tax and financial experience. Prior to joining Bonadio in 2008, Turoski was managing member of DR Financial Services, which merged with Bonadio to form Bonadio Wealth Advisors.