Millions of American households will soon receive tax refunds. According to the IRS, the average tax refund last year was nearly $2800.
It will be tempting to use the refund to buy some big-ticket items on your wish list or go on a much-needed vacation, but you may want to resist the urge to splurge and use that refund to pay down high interest debt or to get ahead in savings.
Here are a few ways to get the most benefit from your tax refund:
* Pay off credit card debt. Paying a large amount of your debt on a high interest rate credit card helps you in several ways. You will reduce the amount of interest penalties, but also decrease the number of monthly payments that you will have to make. Paying down your debt will also gradually help you improve your credit score. If you have several cards, be sure to first pay off the card with the highest APR.
* Pay off other high interest debt like payday loans or other loans in collection. Many people who have payday loans can’t afford to pay them and fees roll over until interest payments cost much more than the loan. It is also a good time to pay off late bills and get credit collectors off your back.
* Build up savings. This is a good time to build up your emergency savings or save for a car, the down payment on a house, or even a vacation. Set up a separate savings account for your refund and add to it when you get extra money from gifts, bonuses, and next year’s refund. An emergency fund will keep you from using a credit card during a crisis and protect you from going into debt from unexpected expenses
* Make a contribution to your IRA. If you have low to moderate income, you could be eligible for a tax credit or a tax deduction. With a $2,000 IRA contribution, you could receive $1,300 in tax refunds.
* Save for college in a 529 College Savings Plan. The contributions can grow and there is no tax when the money is withdrawn for education expenses. You may receive a deduction on your state income tax if you use your own state’s savings plan.
* If you have borrowed from your 401K loan, use your refund to pay it back. If you leave a job, these unpaid loans are taxable when you leave your job.
* If all other debts are paid, make an extra payment on your mortgage. This additional payment may save thousands of dollars in interest and pay off your mortgage faster.
This is also the time to analyze your tax withholdings. A refund means that too much was withheld from your paycheck and you are giving the government a free loan. If you receive a large refund but struggle to pay the bills every month and keep adding to your debt, it could be time to reduce the taxes withheld from your pay. This will result in more income each month to pay your bills and avoid more debt. If your refund is $3,000 a year, that is $250 a month that you could use to pay on bills or decrease your debt.
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