If you have recently received a refund check, consider using it to strengthen your personal balance sheet rather than spending it. As of February 28, 2014 the IRS has issued $147 billion in tax refunds. The average refund this year is $3,034, which is an increase of 5.6 % from this time last year. That’s a nice chunk of change! Here are five smart uses for your refund.
Pay Off Credit Card Debt.
The average US household with debt has around $15,000 in credit card balances with an average Annual Percentage Rate (APR) of 15.38%. If you’re currently only making the minimum payments on a $15,000 balance, making a one-time $3,000 payment would save more than $19,000 in interest and shave 9 years off the payoff date. Using your refund to pay off or pay down credit card debt is like earning 15.38% on an investment (depending on your APR). That is an incredibly valuable use of your money!
Start or Rebuild Your Emergency Fund.
If you don’t have any credit card debt, the next best option is assessing your savings. Nothing can derail your financial plans more than having inadequate cash reserves when you need them. Those who are unprepared for unexpected job loss or expenses are then forced to borrow at high interest rates or liquidate other investment assets at inappropriate times. Sadly, the number of Americans with no money saved for emergencies has risen to 28% according to Bankrate’s Financial Security Index. Your goal should be to have at least 3-6 months of expenses saved in your emergency fund, and this money should be easily accessible in a money-market or savings account. An Emergency Fund is a vital piece to your financial security and is definitely a smart use of your tax refund.
Boost Your Retirement Savings.
If you don’t have substantial credit card debt and you have an emergency fund, great work! A Roth Individual Retirement Account (IRA) allows you to put money away that will grow to be tax free after age 59 ½ (as long as the account has been open for 5 years). If you contributed $3,000 today and continue to invest your $3,000 tax return each year, assuming the account earns 7% annually, your IRA will be worth over $140,000 tax free in 20 years. One great benefit is that in the meantime your contributions are still accessible. If you need to withdraw them early you can without paying a penalty. The earnings may be subject to taxes and penalty if withdrawn before attaining age 59 ½ (exceptions include when the earnings are used for education expenses or a first-time home purchase). In 2013 and 2014, eligible participants can contribute $5,500 to a Roth IRA or $6,500 if you are over 50. Since Roth IRA dollars are contributed after taxes and have no effect on your current tax liability, you can still make a contribution for 2013. Contributions made before April 15, 2014 can be counted towards 2013, even if you have already filed your taxes.
Start an Investment Account.
Another option to grow your refund besides a Roth IRA is starting an investment account. Maybe there is a mutual fund or stock you’ve been considering that isn’t available in your 401(k). If you aren’t confident in where to start or what investments to choose, an account with our partners at Betterment is a great option. All you need to do is decide on an allocation between conservative and aggressive (how much risk you’re willing to take) and leave the rest to the experts. This account has no minimum balances, no transaction fees and low management fees. For more information visit http://www.betterment.com/ubt.
Pay an Extra Principal & Interest Payment on Your Mortgage.
If you have all of previous things in place, paying off your house early is way to save money in the future. Paying off your mortgage may seem far away; 15 or maybe even 30 years. However, did you know that simply making one extra principal and interest payment each year will take years off of your mortgage and save you a substantial amount of interest? For example, if you have a $150,000 loan at 4.5% for 30 years, your principal and interest payment will be around $760. If you pay an additional $760 one time per year each year towards the loan you will pay your mortgage off in 25.5 years rather than 30 and save over $21,000 in interest! Or if you just pay an extra $100/month for a total of $1,200/year for the life of your mortgage it will be paid off in 23.6 years and you will save almost $30,000 in interest.