Use tax refund to help pay down debt
By Eileen Alt Powell
Associated Press
NEW YORK — The Internal Revenue Service says some 93 million Americans — roughly seven out of every 10 tax filers — are getting a refund on their federal income taxes this year, and that refund will average $1,954.
If you're getting a large tax refund this year, but don't want such a big one next year, ask your employer for a new W-4 form and increase the number of exemptions you claim. IRS Publication 919, available on the IRS Web site (www.irs.gov) or by calling the IRS hot line, (800) 829-3676, can help you do the calculations.
Many will be tempted to spend it all, and quickly. But financial advisers say there are a lot of alternative uses that will provide longer-term financial rewards.
How to get less money withheld
"It's fun to get a tax refund, and people should use some of it for something special, like a nice dinner out, an upgrade for their computer or maybe a new spring hat," said consumer expert Nancy Dunnan, author of "How to Invest $50 to $5,000."
"But it's also an opportunity to pay down debt or to boost savings."
Greg McBride, an analyst at Bankrate.com, suggested that one of the most profitable things people can do with their refunds is to pay down credit card debt.
"If you pay $1,900 on a card that charges 13 percent interest, you'll save $247 in interest this year," he said. "That's money well spent."
Another possibility, McBride said, would be "starting that emergency fund we all talk about but never quite get around to."
Most experts say an emergency fund should be big enough to cover three to six months of living expenses if you lose your job, have medical problems or face other unexpected setbacks.
"The money should be accessible, but shouldn't be something you're tapping all the time because that defeats the purpose," McBride said.
He suggests savers consider putting their money in high-yield money market deposit accounts, currently paying about 2.6 percent interest, or money market funds.
Although savers shouldn't raid their emergency funds for non-emergencies, they can "leverage" the money, McBride suggested.
"Think about increasing the deductible on your auto insurance by the amount you have saved, and that will cut the cost of your insurance," McBride said.
Liz Miller, a senior vice president and investment officer at UMB Bank in Kansas City, Mo., suggests families consider investing tax refunds for their retirement.
"An IRA — Individual Retirement Account — is a good idea for everyone," she said.
Employees who don't have retirement plans at work can invest up to $3,000 a year in traditional IRAs. Those with 401(k) and other employer-sponsored plans can look at supplementing them with Roth IRAs. People 50 and older can put in an additional $500 under a special "catch-up" provision.
IRA accounts can be set up with banks and savings institutions as well as with brokerage houses.
Miller believes good investment options now include equity funds that invest in small companies. "Small-cap equity funds do best in the early stages of economic recoveries, which is where we are now," she said.
All the experts said that while it might feel good to get a big refund, it's not necessarily a winning strategy.
"A lot of people view a tax refund as a gift," Miller said. "You have to change that mindset. It's your money, and a big refund means you gave it to the government as an interest-free loan."
Dunnan agreed, pointing out that "in theory, you shouldn't be getting a refund if your withholding is correct, or if your estimated quarterly payments are at the right level."
