If you are expecting a tax refund this year, you need a plan for your money. It’s tempting to consider your refund “free money” or “found money”. Don’t fall into this thinking trap. Remember, the government is not sending you a bonus check. It’s money that should have been in your pocket all along! In fact, if you are receiving a large refund, it is a good idea to review your W-4 form and adjust withholdings as necessary.
Experts agree that the smartest thing to do with a little extra money is to use it in a way that benefits your budget, generates extra income, or helps you achieve financial peace of mind. This can be accomplished in several ways, and this week’s blog outlines a few options for you.
- Fund a Health Savings Account (HSA). If you participate in a health insurance plan with a high deductible, you may be eligible to open and contribute to an HSA. These accounts allow for tax-deductible contributions, which saves on taxes in the present. When withdrawals are used to pay for qualifying medical expenses, the funds come out of the account tax free. It’s a powerful contribution. The 2015 contribution limit is $3,350 for individuals and $6,650 for families, with an additional $1,000 allowed for those over age 55.
- Complete an estate plan. One of the most common excuses for putting off estate planning is cost. Effective legal documents and periodic reviews are crucial to creating a successful estate plan that will transfer your wealth to your loved ones according to your wishes. Using your refund to plan for yourself and your family can give you peace of mind that is priceless. To learn more, please view our estate planning toolkit.
- Focus on your home. If you are a homeowner, investing in home improvements can immediately increase the value of your home. Even a small refund can pay for painting a few rooms, updating bathroom sinks, or even a fence for the back yard. Another option is to make an extra mortgage payment with the funds. Even one extra mortgage payment per year can reduce the term of your mortgage and save you thousands of dollars in the long run.
- Complete a financial plan checkup. Take a hard look at your savings goals to see if you are on track. Depending on your income level, goals, age, and whether you have already fully-funded your employer sponsored retirement accounts, using your tax refund to get a head start on Roth IRA contributions or 529 college savings plan contributions can be a great move. Make sure to speak with your advisor regarding your specific situation.
- Invest in yourself. Take a class that is of interest to you or one that will help to advance your career. Dedicating yourself to being a lifelong learner is something that can enrich and add value to your life. Plus, there are two educational tax credits that can make this more attractive. The American Opportunity credit equals 100% of the first $2,000 of a student’s qualified education expenses plus 25% of the next $2,000. The maximum annual credit is $2,500. The Lifetime Learning credit equals 20% of up to $10,000 of qualified education expenses. The maximum credit for 2015 is $2,000 before any phase-outs. Please note that there are income limit restrictions associated with both credits. You also cannot claim both the American Opportunity credit and the Lifetime Learning credit for the same student in the same year.
According to the IRS, about 77% of refunds are directly deposited into bank accounts, which is a smart and efficient thing to do. However, retailers know that when people have extra money in their checking accounts, they can be tempted to do a little extra spending. The longer money sits there, the greater the temptation. If you need time to decide how to best utilize your refund, do yourself a favor and move it out of your everyday checking account and into a savings or investment account. Regardless of how you spend your refund, remember that it’s your hard-earned money, not a windfall — so be sure to use it wisely.