10 Smart Ways to Use Your Tax Refund
How to resist the urge to splurge and make better decisions with your money
En español | This is the time of year when many Americans start salivating over their federal income tax refunds.
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And why not? The IRS says the average refund issued so far in 2015 is $3,120. It's easy to blow a nice windfall like that by shopping, taking a vacation or buying some high-end electronics. The better financial move is to use that refund wisely. Here's how:
1. Boost your emergency savings fund
Most financial advisers recommend having an emergency fund equal to at least six months' worth of your expenses. That safety net could come in handy when the unexpected happens, such as an illness, job loss or the death of a spouse. "If you are lucky enough to get a tax refund, send half of it to savings," says certified financial planner Donna Skeels Cygan, owner of Sage Future Financial LLC and the author of The Joy of Financial Security. "Saving more money is one of the best commitments you can make," she says, noting that more than one-fourth of Americans have no emergency savings.
2. Pay down debt
Whether it's credit card debt, an auto loan or even college bills, if you're 50 or older, now is the time to start aggressively slashing these debts. Student loans seem to be especially burdensome for people 65 and over. A report by the U.S. Government Accountability Office found that even though Americans ages 65 to 74 accounted for just 4 percent of federal loans outstanding, these borrowers still owed a collective $18.2 billion. And they have much higher default rates.
3. Open an individual retirement account
Socking away money in an IRA may lower your tax bill, and it increases your retirement security. In 2015, the maximum contribution you can make to a Roth IRA or traditional IRA is $5,500, depending on your income and tax filing status. Individuals 50 and over can make an additional "catch-up" contribution of $1,000. Making your IRA contribution before April 15, 2015, allows you to claim it on your 2014 return.
4. Pay down your mortgage
Owing money on a house can be a big burden. "While there is really no escaping the hefty debt of a mortgage, making even one extra mortgage payment a year could end up saving you thousands in interest over the years," says retirement specialist Scott Cramer, president of Cramer & Rauchegger.
See also: When to pay off your mortgage
5. Make home improvements
The annual energy bill for a typical single-family home is roughly $2,200, according to 2009 figures from the U.S. Environmental Protection Agency's Energy Star program. You can do small repairs like sealing the heating and cooling ducts that run through your garage, attic, crawl space or unheated basement. Purchasing a solar water heater may net you a tax credit. Even without a tax perk, going energy efficient is money well-spent.
6. Donate to charity
If you don't really need the cash, use your refund to support a worthy cause. Be sure to get a receipt and also make sure you're contributing only to an IRS-approved 501(c)(3). That way, you can get a tax deduction next year for your generosity.
7. Open or contribute to a 529 plan
A 529 is a college savings plan used to help fund your child's or grandchild's higher education. With rising tuition prices, many families need all the aid they can get. You can learn more and open an account at Savingforcollege.com.
8. Invest in your career
Take a class to learn something new, attend an industry conference or get an annual membership in a trade group where you can network and enhance your career prospects. These efforts could help with your current job or set you up for a fulfilling second act.
9. Prepay an annual expense
Instead of doling out money each month for bills like car insurance or cellphone service, use your refund to prepay the annual cost of one or more monthly expenses.
10. Apply your refund toward next year's tax bill
If you routinely owe taxes or if you make estimated tax payments (as do many entrepreneurs), you can apply all or part of your income tax refund toward next year's tax bill. Making estimated payments can help you avoid underpayment penalties on next year's return. Line 77 of the IRS 1040 form lets you designate the exact amount of your refund you'd like applied to your estimated taxes.
See also: Need help filing your taxes? Get free assistance from AARP Foundation Tax-Aide
Finally, if you're getting a big refund check, some would argue you probably haven't been doing the best financial planning. You might want to consider not getting a refund next year and instead taking home more money on a regular basis. Form W-4, which your employer gives you, indicates your filing status and allowances. The more exemptions you claim, the less tax your employer withholds from your paycheck.
"Although most people like a big tax refund at the end of the year, this simply means you are giving the government an interest-free loan. When you put it in those terms, that check from the IRS doesn't seem so attractive anymore," says CPA John Vento, president of a New York City-based accounting firm that bears his name. "Trust me, there is no easier way to improve your cash flow than by adjusting your exemptions so that you are not overpaying your tax with each paycheck."
Lynnette Khalfani-Cox, The Money Coach(R), is a personal finance expert, television and radio personality, and regular contributor to AARP. You can follow her on Twitter and on Facebook.