If you’re looking forward to a tax refund in the coming weeks, you have good reason to be optimistic: the IRS reports that about 77% of tax returns filed last year generated a refund, and the average reimbursement was $2,815.
Even though what may look like a gift from the government is actually a deferred receipt of your own money, the best use of these funds is not always obvious. This year, the issue is even trickier, with many households facing growing financial pressure from inflation, rising interest rates and the expiration of pandemic-related government assistance programs. Advance child tax credits, for example, which offered families monthly checks based on their income and number of dependents, have ended pending further action by Congress.
“For many people, Child Advance Tax Credits have become part of their budget, so you should consider saving your tax refund and using it to supplement your monthly budget in the future,” says Tommy Blackburn, Certified Financial Planner in Newport News, Virginia. . “It can help with monthly cash flow,” he adds.
Another option is to adjust your withholding tax with each paycheck so you don’t pay more tax than necessary. But, adds Blackburn, some people prefer to receive a lump sum each year as a forced savings method.
While your refund priorities depend on your particular situation, there’s room in almost any budget to spend at least part of your refund check on something fun, too. Here’s a roadmap to help you decide what to do with the money:
SAVE FOR THE NEXT EMERGENCY
“First, think about your short-term security,” suggests Vince Shorb, CEO of the Las Vegas-based National Financial Educators Council, which supports financial wellness educators. “There’s a lot going on, from COVID to inflation. I want to make sure people have food on the table and gas to get to work,” in case of an emergency like job loss or an unexpected expense, he says. This means putting money into an emergency savings fund before any other priorities, including paying down debt.
“With inflation, you want to save a little more than normal to prepare for those crazy gas and food prices. We don’t know what’s going to happen next,” says Scott Alan Turner, CFP in Aledo, Texas. While financial experts often cite the goal of having three to six months of hidden expenses, a more realistic goal may be to save $500 to $1,000, or at least half of your repayment. Given the rising prices, Turner says it’s best to save more if you can.
“If your industry is shrinking, you’ll need a larger emergency fund,” Shorb says, because it could take longer to find a new job if you lose your current job.
DISCHARGE HIGH INTEREST DEBT
With interest rates set to rise this year, credit cards and other variable-rate debt would likely become more expensive, making using repayment money to pay it off a smart move, says Mike Biggica, CFP in San Francisco. He suggests paying off any debt bearing an interest rate of 6% or more and also focusing on student loans, medical debt and anything bearing a variable rate.
Maggie Klokkenga, a financial coach and CFP in Morton, Illinois, suggests using an online debt calculator to see how making extra debt payments can speed up the debt repayment process. This can help you decide whether to pay off your smaller debts first or those that bear a higher rate of interest. “You can see how quickly you can pay it all back,” she says.
ALSO MAKE ROOM FOR OTHER OBJECTIVES
If you’ve already paid off your emergency fund and high-interest debt, Klokkenga suggests putting the cash repayment into high-yield online savings accounts dedicated to different purposes, such as a vacation in Cabo. or retirement. “When it’s not in your checking account, it’s harder to access and gives you pause before you can get the money,” she says.
Increasing your contributions to existing retirement accounts such as a 401(k) is another solid option, says Biggica. “For people who aren’t already maxing out their 401(k), this increased contribution makes them feel more secure and responsible.”
In some cases, you can preload your contributions, Biggica adds, which means you reach the annual contribution limit before the end of the year. As a result, your take-home pay will be higher by November or December, providing flexibility to pay year-end expenses like vacation expenses.
SPLASH WITHIN LIMITS
After taking care of emergency savings and debt repayment, there might not be enough repayment left to make a huge purchase like a car, but Turner suggests squeezing something nice. “Go out and celebrate with something frivolous and entertaining: a nice steak dinner, brand new jeans, concert tickets,” he suggests. Her guideline: Plan to spend about 10% on fun. For the average refund recipient based on last year’s IRS numbers, that’s about $280.
It probably won’t fund a vacation, but it could dramatically improve your weekend plans.
This column was provided to The Associated Press by personal finance website NerdWallet. The content is for educational and informational purposes and does not constitute investment advice. Kimberly Palmer is a personal finance expert at NerdWallet and author of “Smart Mom, Rich Mom.” Email: kpalmernerdwallet.com. Twitter: Kimberly Palmer.
By KIMBERLY PALMER of NerdWallet
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