With the passage of the April 15 tax deadline, many are looking forward to a tax refund. According to Rasmussen Reports, 56% of Americans had already filed tax returns as of April 1 so a lot of you have your refunds already burning a hole in your pocket. What you do with that refund – no matter its size – can make your financial situation better in the future. So, let’s prioritize the best uses of that additional cash.
First, do you have any high-interest credit card balances outstanding? If you do, you should use a large part of your tax refund to put a big dent into that debt. Your return on this investment is at least equal to the interest rate you are paying on your outstanding balance (often much greater than 13%!) on a pre-tax basis. This is a much higher guaranteed rate of return than on any investment alternative at this time. Further, it has been a widespread practice among credit card issuers this year to raise interest rates on borrowers holding balances, so you might see a further increase in your credit card interest rate later this year. Protect yourself and pay down your debt.
Second, do you have ample savings for a “rainy day”? For most, the ideal fund balance is equivalent to at least 6 months of take-home pay. This is particularly necessary in this job environment where economic uncertainty and the prospect of higher unemployment in future months is very realistic. The funds should be put in relatively “liquid” investments such as a mix of cash, money market funds, short term CDs, and savings accounts. Check out your local credit union for some of the highest rates and go online to www.bankrate.com to seek the highest rates for CDs. Make sure the CD issuer is FDIC (or NCUA in the case of credit unions) insured. As long as your CD is less than $250,000, your CD is insured against loss in case the financial institution fails so you do not need to do too much investigation about the CD issuer(you may lose the accrued interest in a financial institution failure so check the fine print in the account agreement). It will give you peace of mind knowing that there is money set aside “just in case”.
Third, are you taking advantage of your company’s 401K options? Unfortunately, a number of companies have suspended or ended their matching contributions to employee retirement accounts in this economic downturn. Some plans will allow a lump sum allocation to your plan but perhaps knowing you have this cushion in the bank encourages you to increase your pre-tax allocation up to the company’s maximum. The value of the pre-tax set aside for retirement can not be understated. The return to you, the employee, is at least equal to your current Federal payroll tax rate since your withheld amount is taken from your pay on a pre-tax basis, lowering the Federal taxes you actually pay as a percent of your gross pay. Most retirement plans have a number of investment alternatives. Typically among the choices is a simple money market account or another low-risk alternative if you are shy of the stock market at this time. You might also look at a bond fund backed by government bonds and T-bills if you are squeamish about equities at this time. Do not be greedy – that probably entails taking more risk with your invested dollars than you need. You can always re-allocate your investments later in the year if the markets start to show more “normal” behavior.
Finally, a good use of your tax refund is a treat for yourself or your loved one. In this time of stress, a good day of relaxation at a spa or perhaps a year’s membership at a local fitness center is a good use of your money. Sure, it is a bit of a splurge, but fitness and relaxation will keep at bay those diseases that will cost you money down the line. And a fit body lends itself to a fit mind, a mind that will help you deal with any unexpected crisis or stress in the future.
There are a range of options for your tax refund. Take stock of your options and make some good choices with the money. You might be able to take advantage of one or more of these suggestions … or one of your own. Good use of your tax refund will pay off in the long run.