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Chandra Orr
Creators.com
Whether you're expecting a few hundred dollars or a few thousand, don't let that tax refund slip away. Should you save it? Invest it? Pay off your credit card bill? In these frugal times, it's crucial to make a wise choice.
"A tax refund is not free money, as many people treat it. It is your hard-earned money. You just paid too much to the government during the year," explains mortgage broker and financial manager Todd Huettner, president of Huettner Capital, in Denver. "If you receive a refund, use it as an opportunity to make up for any overspending or savings shortfall."
Treat your refund like an extra paycheck and put it to work. Use it to pay off high-interest credit cards and start an emergency fund.
*PUT A DENT IN DEBT
"There is no question that the best decision for most people is to pay down revolving debt, typically credit cards," Huettner says. "There is no way you can invest or save this money and get a better rate of return."
Pay off your smallest debts first for a big psychological boost. You'll see the benefit immediately, and one fewer monthly payment frees up funds to tackle larger debts.
"If you continue this strategy -- called debt snowball or debt stacking -- you'll see a progressively higher payment going to the next balance, and you'll notice how fast your debts get eliminated," says financial planner Jake Robinson, regional vice president of Jake Robinson & Associates.
You'll see a big return on your credit report, as well. Paying down revolving debt is the single best way to improve your credit score.
"It can increase your credit score as much as 100 points in some cases. Improving your credit score even a few points can save you thousands on a home loan, car loan, insurance premiums and even credit card rates," Huettner explains.
*KEEP SOME CASH
In these uncertain economic times, it's essential to have an emergency fund.
"There are still a lot of bad things happening with the economy," says financial planner Jerry Lynch, founder of JFL Consulting, in Fairfield, N.J. "Consumers and businesses are not spending; unemployment is huge; the housing market is in the tank; and the banking industry still has a lot of issues. I would rather stay conservative and have cash available in the event of another market drop than spend the cash and have no options."
Think of it this way: Should the need arise, it's better to spend your savings than rack up more credit card debt. In an emergency, cash in hand is better than a credit card with a zero balance.
Set up a savings account. Avoid the temptation to dip in by making the account difficult to get to. "Put it in a bank where you can't get it easily -- a bank on the other side of town -- with no debit card or check writing," Lynch advises. "Putting money into savings and spending it next month does absolutely no good."
Ideally, you should have enough in your emergency fund to cover three to six months' worth of living expenses, but even $1,000 can make a big difference.
"This will handle most minor emergencies without having to charge your credit cards back up," Robinson says. "If your hot water heater goes out or the transmission in your car goes kerplunk, your emergency fund will allow you to face the situation with a modicum of relief."
*OPT OUT NEXT YEAR
If you received a large refund, don't make the same mistake next year.
"There's no reason to let that money sit at the Treasury and not receive any interest on it," Huettner says.
Talk to your employer about amending your W-9 form. Take more exemptions to have the government withhold less from each paycheck, and then put that money to work during the year.
A typical $3,000 tax refund could mean an extra $250 in your paycheck each month. Up your 401(k) contribution, and have the difference automatically deposited into savings, or apply the extra to your credit card bills.
"Most middle-income families receive $2,500 to $3,500 each year in a tax return. They typically have that much, if not more, in debt," Robinson says. "They spend money throughout the year on credit cards, get a tax return and pay toward the debt, and then start the cycle all over again."
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