Smart Ways to Spend Your Tax Refund
There are many ways to spend a tax refund, but using it to get back on track is money well spent. Here are tips to ensure you use your money smartly.
1. Play catch-up
Once your refund hits your bank account, pay off any overdue bills. Start with the ones that are reported to the credit bureaus — like medical expenses and mortgage payments — so that you can protect your credit score, says Justin Fulton, a financial planner with Signature. Payment history makes up 35% of your total credit score. And settling your bills has a second benefit, as it also puts an end to late fees.
2. Prepare for the unexpected
Next, start — or replenish — an emergency fund. You should have six to eight months of living expenses set aside. Conventional wisdom used to be that three months' worth was sufficient, but it can now take at least half a year to find a new job after a layoff, says Fulton.
3. Attack your debt
As long as you're on schedule, your top worry shouldn't be your mortgage or any student loans, since they tend to carry low interest rates and are also tax deductible, says Stuart Ritter, a financial expert with T. Rowe Price. Instead, focus on anything with a high interest rate, like your credit cards or car loans. Instead of putting a little bit of money toward each credit card, consider attacking one at a time, which will stop interest from racking up. Be sure to start with the one charging the highest rate.
4. Save for retirement
Make sure you're forking out enough to get your company's 401(k) match. Then continue to increase your contribution until you reach the amount of your tax refund. Try to hit the annual 401(k) maximum: For 2013 the limit is $17,500, and $23,000 for those 50 and older. If you don't have access to an employer retirement plan, stash your money in an Individual Retirement Arrangement (IRA). With traditional IRAs, taxes aren't paid until you withdraw funds; taxes are paid up front with a Roth account. Those earning less than $188,000 for married couples filing jointly and $127,000 for those filing solo qualify for a Roth IRA. For 2013, you can contribute up to $5,500; add an extra $1,000 if you're 50 or older.
5. Invest in your children's education
If you're fortunate enough to still have money left over, put it toward your kids' college education. One of the best ways to save is with a 529 plan. Distributions are federal-tax-free; many states also let you deduct some or all of your contributions.
Avoiding an Audit
Approximately 1.6 million taxpayers were audited in 2011. You can lower your odds of being one of them by following our tips:
- Check your numbers. An innocent math mistake or even a wrong Social Security number could raise a red flag.
- E-file. A return submitted electronically is 20 times more likely to be accurate than one done manually, says Bob Meighan, a lead CPA with TurboTax.
- Keep detailed records. For small business owners especially, a return from a cash business can raise eyebrows. Get into the habit of using accounting software.
New Jersey-based financial expert Stacey L. Bradford is an award-winning journalist and author. When she isn't writing, she's busy teaching her kids the value of a dollar.
Originally published in the April 2013 issue of Family Circle magazine.