Take Advantage of Your Tax Refund – Get Out of Debt More Quickly

This year, more than three out of four individual taxpayers will receive a tax refund. For these consumers the average refund will be approximately $2,400.00. If you are one of the many to receive a refund you have probably been thinking about what you should do with the money. I know many of you already have the money spent - even before you get it. However, instead of spending your tax refund on some new CDs, a laptop, a vacation, or a big screen television, you should use this money to get ahead financially. If you evaluate your financial situation you may find better uses for the money than spending it on material items. One wise option is to use it to pay down your credit card debt more quickly. At the conclusion of this article, I’ll also address how you can use alter your current taxes to help you immediately – instead of waiting until next year’s refund.

Although, most of you have the best intentions about using your refund, the reality is most consumers will spend a large chunk of their refund on luxury items before even considering their outstanding debts. This is incredibly hard to understand since so many have already fallen behind on monthly bills and other debt. Credit card interest rates are higher than ever so it costs consumers more and more to carry a balance.

Here are some simple tips for putting your tax refund to work for you.

#1. First and foremost you will want to reduce high-interest debt first. Pay down credit cards with the higher interest rates, first. If you hold a balance of $9,000.00 (the average amount of credit card debt carried by a person in America) at an interest rate of 18% and you are making the minimum payment of 4% (most creditors are now charging 4-5% for your minimum payment.) per month, it will take you about 175 months to pay off the debt. You will pay roughly $5,315.67 in interest. When added to your principal of $9,000, your total cost is about $14,315.67. However if you were to take $2,000 of your tax refund and paid it toward your debt now, you will be able to pay the debt off nearly 1 year sooner AND you will save approximately $1,200 for a total cost of about $13,100.

#2. Paying down your mortgage is another great way to utilize your tax refund. If you reduce your mortgage balance it could mean substantial long-term savings. Any extra mortgage payment you are allowed to make goes directly toward your principal allowing you to pay off your mortgage faster. This will also save you on interest costs. However, for some, accelerating mortgage payments isn't always the wisest decision. It depends on your current mortgage and rate as well as other investment possibilities. I would suggest consulting a financial advisor before making any extra payments.

#3. Another way to use your tax refund to help you get ahead is by putting it into a retirement plan. You could increase your contribution to your 401(k). If your employer matches 50 cents to each dollar you contribute up to a specified percentage of your paycheck you could really see the benefits. If you do not currently have a 401(k) or other retirement options offered by your employer, you could always start an individual retirement account (IRA). If you are self employed, talk to your financial advisor about contributing to a SEP. If you have maxed out your contributions on any of these accounts for the year, you could look into tax-efficient mutual funds or possibly an annuity.

#4. Begin to establish an emergency savings fund. Almost 60% of American households, with children under 18, live paycheck to paycheck. It could possibly save you from having to put an emergency car repair or doctor bill on your credit card, or having to rob from Peter to pay Paul. Having an emergency fund could prove to be a valuable asset. Put the money into a money market account or high yield savings account. You’ll earn 4-6% on your money. If you ever have an emergency, instead of having to charge your credit card and incurring more interest charges, you’ll have the cash available.

#5. If you have children, another way to plan for the future is to start a college fund. By investing in a college account for your children you will give them an advantage, and help take the stress off of the thought of planning for their future. Use your tax refund to start the fund. The younger your children are when you start the fund the more it will be able to grow. There are many options for college saving such as a Coverdell education savings account, which is a trust or custodial account set up solely for the purpose of paying qualified education expenses for the designated beneficiary of the account. You could also consider investing in the tax-free growth of a 529-college savings plan. This plan is an education savings plan that is run by a state or educational institution and is designed to help families save funds for future college costs. As long as the 529-plan satisfies the basic requirements, the federal tax law provides special tax benefits to you, the plan participant. Any of these options can help provide for the education of your children.

If you find that you are still falling behind, you may want to look into changing the amount of deductions from your paycheck. Allow yourself more money throughout the month rather than using the IRS as a no interest savings account. Many consumers think that getting a refund is a positive. In some cases it is. But in other cases, it just means that you paid too much to the Government in taxes throughout the year and are getting it back in the form of a refund…months later. But the Government does not pay you interest on your money while it holds it. Rather than using the IRS as a no interest savings account you should consider adjusting your W-4 so that you are able to get the maximum amount due to you every month. Then you will have more money each month to pay down your debts. Do not use these extra funds to purchase unnecessary items. Take advantage of the increased cash flow to get out of debt more quickly. You will, however, want to seek the advice of a tax professional before making this decision. If not enough money is being withheld, you could find yourself owing money to the IRS at the end of the year.