Here’s what to do with your tax refund
Each April, Americans ride an emotional roller coaster.
We dread Tax Day, as evidenced by the fact that 35 percent of people would rather discuss sex with their kids than prepare their taxes, while 13 percent would prefer to spend the night in jail.
Yet we love our tax refunds, even though it means we’ve effectively given the government an interest-free loan. Nearly half of all taxpayers expect a refund this year, according to WalletHub’s 2016 Taxpayer Survey, and the real question is: How are we going to put this windfall to use?
A financial safety net serves as a form of insurance should you encounter unexpected expenses or a loss of income. So make sure to either start one or increase your contributions if you’re already partially protected.
The best way to do so is to set up automatic monthly transfers from the account in which your employer deposits your paycheck to a separate savings account. And it’s best to do so soon after you receive each paycheck in order to ensure this priority doesn’t get shirked. Strive to set aside three months’ take-home pay as a preliminary goal, with the padding of more than one year’s income your ultimate objective.
2. Debt payments should be a high priority, if applicable.
Using your tax refund to repay amounts owed is extremely wise, considering how costly most types of consumer debt are, not to mention how much of it we have.
For example, the average household with credit card debt would spend more than $1,800 on interest while paying off their $7,879 balance over 36 months, based on the average credit card’s 13.93 percent annual percentage rate (APR). But if you could manage monthly payments of $488, thereby halving your debt-freedom timeline, you would save more than $900.
Doing whatever you can to get out of debt is especially important these days, as we’re collectively racking up tabs reminiscent of the run-up to the Great Recession, including $71 billion in new credit card debt during 2015 alone. We don’t want to find out where the tipping point at which we can no longer maintain these lofty balances actually is, as the resulting fall could get nasty.
3. Use it for motivation.
Earmarking a portion of your refund for future fun is a great way to make boring necessities easier to stomach. It’s a reward, and tying this treat to a particular task that you’ve been putting off for a while can be especially helpful.
You could, for instance, make a deal with yourself where you’re allowed to buy that fancy pair of shoes you’ve been eyeing if you do a thorough review of your credit report and make a budget. By the way, you can check your full credit report as well as your credit score for free on WalletHub, the only site to update both daily.
4. Consider it investment ammo.
Using your refund to maximize your annual retirement contribution or simply holding it in a money market account until the stock market provides an attractive entry point will enable you to turn however much you receive back from Uncle Sam into a significantly larger amount years down the road, thanks to the power of compound interest.
Finally, it’s important to note that the options for actually receiving your tax refund are not created equal. In particular, opting for a prepaid card tends to be a bad choice, as prepaid cards are known for having numerous small fees that can make accessing your money quite expensive. You don’t want to leak money in this manner, so stick to direct deposit or a paper check. And don’t worry, tax season will be over soon!
Written by Odysseas Papadimitriou, the CEO of the personal finance website WalletHub — which offers free credit scores, full credit reports, and customized advice. Published on A Plus in April, 2016.