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Those magical words - IRS refund. Yes! Free money. At first you are ecstatic, this is the answer to all your desires. Then after the glow of hearing about your return you start to think of all the places you should or could spend it: I could pay off my credit cards (almost!), an extra mortgage payment or two, we could put a new roof on the house, buy the new bedroom set, invest in stocks or an IRA, or maybe take a cruise. Suddenly that large return doesn't seem so large anymore. What should you really do with that refund? What takes the highest priority? What is the best use of that money?
First, an IRS refund is not FREE money. It is money that you have lent to the IRS at 0% over the last 12 months. This is not a savings account. If you are getting a substantial refund, it is time to review your withholdings. Are they correct? Should they be increased? Even if you only receive an increase of $5 - $7 per paycheck, this is a substantial amount over the course of a year and can even earn interest if invested wisely. The extra money can also be used to pay down your debt or begin a savings plan. Because you did not have the money before, you should not miss it when it goes straight into an investment. (If you have any questions, it may be wise to speak with an accountant or other knowledgeable person.)
Second, there is no right answer as to what to do with the money. It's your choice. Each situation is unique and the solution may be different for each family. Take some time to think about it; do not do anything rash. Discuss alternatives with a spouse or trusted friend. For some, paying off credit cards will give the greatest economic boost. For others, investment is the answer. For still others, the mental boost of being able to spend some "self" money without worrying about disrupting the budget is the way to go. For my family, we usually use a combination of these.
Option number one, paying off credit cards, gives you a double bang for your buck. Not only do you reduce or eliminate what you owe, but you also do not continue to add to your debt with interest payments. Interest payments can add 7% - 25% annually to what you owe. As for which bills to pay, there are two schools of thought. One is to pay the card with the highest interest rate off first. The second is to pay off the lowest balance first. By paying off the card with the highest interest rate first, you will prevent accumulation of future interest. But, by paying your smaller bills off, you may free up more of your overall monthly budget (fewer minimum monthly payments to make). Take the time to calculate the different scenarios to decide which is best for your situation.
Investing is a very important option, especially if you have not yet established a nest egg. (A nest egg is money that you would need to rely on in an emergency and should equal 3 - 6 months of your income.) If you plan to establish your nest egg with this money, be sure to keep the money in a semi-liquid state - savings accounts, certificates of deposits, money market accounts, or bonds. If your nest egg is already established, it may be time to look into longer-term and higher-rate investments such as real estate, stocks, and mutual funds. Perhaps opening or adding to an IRA would be your best choice and can in some cases help with your tax burden next year. If you are do not feel comfortable in the investment arena, consult someone who is or read books or periodicals that can help you make the best choices.
For many people, including my husband, a refund is considered "unexpected" money and therefore should be used for those things that we can never seem to afford on the other 364 days. Some of these items gain you nothing but the feeling of release and wealth, such as clothes, toys, decorations in the house, etc. Others can bring a return in the long run, such as remodeling the house (a partial return when selling the house) or working toward a degree (the future increase in salary). An additional opportunity for "unexpected" money is donation. Not only can you help someone in need, but the donation can be deducted next year (be sure to retain a receipt).
No matter what you chose to do with the money or how you chose to divide it among the possible choices, be thankful that you are not one of the many trying to figure out how to pay their tax bills. Happy Tax Day!
Dawn Adams is the Editor of A Personal Touch. A Personal Touch is designed to help you improve your marriage, family, home, and entertaining on a budget. To receive a complimentary emailed copy send your request to apersonaltouch@snet.net or to order 12 monthly issues send $12 (for email) or $15 (for 12 print) to A Personal Touch, 24 Flintlock Dr. Durham, CT 06422. Mention The Dollar Stretcher and receive $1 off.
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