It’s that time of year where many of you will receive your 2020 tax refund. Many look at tax refunds as a bonus or as found money and spend the newfound money frivolously. There is absolutely nothing wrong with rewarding ourselves, especially this year. However, I also encourage you to look at your tax refund as an opportunity to help you get yourself in better financial shape.
Last year the average tax refund was nearly $3,000. Although $3,000 is not game-changing money, it is enough to make an impact on your financial affairs. This is an opportunity that you should take advantage of to better your financial situation. Here are some ideas for your 2020 tax refund that could help with your overall finances.
If you have credit card debt, the best financial move you can make is paying down that debt. After all, with the average credit card interest rate in America at nearly 20 percent, coupled with the fact that the interest is not tax deductible, paying down credit card debt earns an after-tax return of 20 percent.
I can assure you no investment can guarantee you a higher rate of return. In addition to the rate of return, when you pay down debt you are also significantly improving your financial health, and we all know your financial health is key to your overall health.
If you do not have debt, a tax refund can go a long way in helping you build an emergency fund of money. I’ve always believed that we all need money set aside to handle unexpected expenses such as a new furnace or repairs on your car. As opposed to going into debt for these items, it’s nice to have an emergency fund you can tap into.
Typically, I tell individuals that they need three to six months of living expenses as an emergency fund. If you have not set up an emergency fund, using your tax refund is an excellent way to go.
Another option for your tax refund is to invest the money. If you qualify, you can make a Roth IRA contribution and have that money grow tax free. I am a believer that you can’t save too much for your future. If you don’t qualify for a Roth IRA, investing the money outside an IRA is another opportunity to consider.
Another potential investment opportunity is to use the money to save for a child or grandchild’s college education. Using a 529 Plan such as the Michigan Education Savings Plan, allows you to invest money tax free for a loved one’s education. We all know how expensive college is, and anything you can save to help a loved one with their education, will be greatly appreciated.
Unfortunately, when it comes to tax refunds too many people deposit it in their checking account and before too long the money disappears, and they have no idea where the money went. I encourage you to be smarter with your tax refund and look for opportunities to better improve your financial situation.
Yes, spending money frivolously can have short-term benefits, but those benefits will be forgotten before you know it. On the other hand, if you do something smart with your tax refund, it will pay dividends for years to come.
Remember, if you are receiving a large tax refund, it may mean that you have too much money withheld from your paycheck. If that is the case, you may want to adjust your withholding so that your weekly paycheck will be a little higher and your refund a little lower. A large refund means that you’ve given the government an interest-free loan.
Giving the government an interest-free loan is not a good financial move.
Rick Bloom is a fee-only financial advisor. His website is www.bloomadvisors.com. If you would like Rick to respond to your questions, email Rick at email@example.com.