Published April 19, 2011
Whoo hoo! A refund. Speaking personally, this is the first time in about 10 years that I’ve qualified for a refund. I think it’s because I took this full-time job at Reuters and signed up to have big bucks deducted from my paycheck. And it’s because 2010 tax breaks passed retroactively actually lowered my total tax bill (and those of many others).
This year, the average tax refund is pushing $3,000, according to the Internal Revenue Service. Many financial advisers believe that it is a big mistake to get a big refund. Getting a big refund means you’ve loaned the IRS money all year long without earning a penny in interest. “My gripe with large tax refunds… is two-fold,” Eleanor Blayney, the consumer advocate for the CFP Board of Standards, said in a recent press statement. “First, they make mincemeat of any attempt to manage your cash flow. Second, they often go unplanned.” She advocates budgeting your taxes as closely as you possibly can to the amount you’ll actually owe when the year ends, and integrating the extra cash you’re not sending the IRS into a reasonable spending and saving budget.
That makes sense, but realistically, with interest rates at their current low levels, it doesn’t matter that much. For example, the average bank money market account is paying 0.63% interest a year, according to Bankrate.com. So, even you had the whole $3,000 at the beginning of the year (which you don’t, you’re having it withheld week by week from your paycheck), you would earn only $18.90 a year in interest. If sending extra to the IRS helps you to acquire a solid chunk of change in a way that’s relatively painless, go for it.
The bigger challenge is putting that $3,000 to good use now. If you blow it all on spring shoes and sidewalk cafes, you’ll be sorry. Here are some tips.
* First, find it. The IRS allows you to track your refund online, so you’ll know exactly when it is coming. Of course, if you authorized the IRS to dump it directly into your checking account, and you filed electronically, you should get it in a jiffy. Last year, TurboTax customers who fit that profile saw their money in between eight and 15 days, the company said. Paper filers who insisted on a check had to wait as long as six weeks.
* Attack those credit cards. Roughly one in five Americans expect to spend their refund paying down credit card debt, says Experian, a credit reporting company. That’s good. Because at the average credit card interest rate of 14.43% (also from Bankrate.com), that $3,000 will save you $432 in interest in a year. That’s a significant amount of money. If you still owe money on your credit cards and you’re getting a big refund, consider cutting the amount of money you have withheld for taxes, and using the difference for an automatic payment on your credit cards. You won’t notice the difference in your take-home pay, and you’ll be saving 14.4% interest on every dollar you pay off. That is better than a refund later.
* Buy more tax savings with it. If you have no credit card debt, you have more options. You can use that refund to invest in an individual retirement account or 529 college savings plan. Either will produce tax savings in the future. Use it to pay for continuing education, and it may well be deductible. Give some of it to charity and there’s another deduction. Of course, deductions are only worth a fraction of the actual cash spent, but the higher your tax rate, the bigger that fraction is. And you get the benefit and the satisfaction of learning something or helping someone.
* Buy an experience. The latest academic research indicates that experiences bring us more lasting happiness than things. Maybe people already know that: Roughly 57% of consumers say they’ll use at least some of their refund on leisure travel this year, according to a survey by Travel Leaders, a travel agency. So, sure, if you’ve taken care of the rest of this list, blow a bit of your refund on some fun. Happy memories may not earn compound interest, but that doesn’t mean they won’t comfort you in your dotage.