The Most Wonderful Time of The Year!
For many people tax return season is a highlight of the new year. Over-paying taxes so that you receive a large return isn’t a wise decision. You are essentially giving the government a 0% interest loan. However it is common for many to have enough deductions and credits to receive a large return. Many companies know this and encourage you to spend your tax return on their products, treating this check as a welcome bonus to your income.
The problem is, it isn’t a bonus. It’s money you’ve earned that is coming back to you in one check rather than over the course of your normal pay periods. Your financial goals should determine where any surplus income goes. That includes your tax return.
Please don’t look at your return as ‘fun money’ unless you have the rest of your financial house in order. If that’s the case your goal should be a $0 return as a result of effectively estimating taxes. Until that day comes, use the return wisely.
January 31st has come and gone, the IRS is officially accepting returns so in light of that here are the top 3 things you should do with your tax return.
#1 Pay Off Your Debts
Yes technically your tax return is your money. However if you are living with any sort of debt including student loans, some of your money belongs to someone else. i.e. the person or entity that owns your debt. Your tax return represents a sweet opportunity to get out of debt and perhaps stop the debt cycle. If you have credit card debt, personal loans, or any type of debt with an interest rate above 7% tackle those first. Pick your debt with the highest interest rate and throw your return at it.
#2 Invest in your Retirement
If you are debt free, congratulations! You are part of an exclusive club and you have every right to take your tax return and invest it in your retirement.
Many young people are intimidated by starting a Roth IRA when you need $1,000-$1,500 to open an account. A tax return is a great way to get your IRA (Roth or traditional) started.
If you already have your retirement accounts set up, great. Transfer your tax return right into them and enjoy the extra boost of momentum it gives you. Think of your tax return as your retirement silver bullet. The U.S. government also offers an incentive for doing this, allowing you to invest money into an IRA up until April 15th. This will then count toward the previous year’s contribution.
For example if you get a $1,500 tax return now in 2017 and had only invested $4,000 in your Roth IRA in 2016 you can take that return and count it as 2016 retirement money. That allows you to max out your retirement savings for last year and allows you to invest the full $5,500 allowed for 2017.
In addition if you choose to invest your tax return in a traditional IRA you can lower your tax liability for this year. Money you invest in 2016 in a traditional IRA can be deducted from your taxes. Not only do you help secure your financial future, but you also lower your tax liability for the next year.
#3 Pad Your Emergency Fund
Finally if you are in the minuscule group that wouldn’t benefit from using your tax return to pay off debt or for your retirement savings (meaning you are debt free and have maxed out your Roth IRA, traditional IRA and your employer sponsored retirement plan) use it to pad your emergency fund. Putting away more for a rainy day is something you won’t ever regret.
Are you going to be getting a tax return this year? What do you plan on doing with it?