This may brand me as a financial heretic, but I don’t have a problem with this.
Consider: A 2011 poll by the National Endowment for Financial Education (NEFE) found that 9 percent of those who receive a refund spend the money foolishly.
But if you triple that figure, you’ll find how many people opt to receive larger paychecks year-round but say they have nothing to show for it.
If I’m not sure whether a client has the discipline to set aside the extra money from each paycheck, I recommend that they get a tax refund. This gives us something that we can use to make a difference. The best time to plan to spend money is when you know it’s coming but before it’s in your pocket.
Since many of you are anticipating a refund, let’s look at some ways to put it to work before it disappears into the netherworld.
IRA: If you qualify to make an IRA contribution (see your financial professional if unsure), add to an IRA. It’s typically preferable to max out the prior year’s IRA (due by April 15) before beginning one for the current year. If you don’t qualify, perhaps your mate can set up a spousal IRA.
In 2011 and 2012, you can contribute $5,000 per person if under age 50 and $6,000 for age 50 or older.
Health Savings Account Contribution: The HSA, based upon pairing a high-deductible health insurance policy with a deductible savings account, is like an IRA for health care costs.
While an explanation of HSAs is beyond the scope of this article, it might be appropriate if you own your own business, are in the 25 percent or higher income tax bracket, have maxed out your other retirement accounts and have money available for more tax deferred savings or if you are in fairly good health and want to cut down on insurance premium costs.
You cannot be covered by another insurance policy or be over 64 to qualify for an HSA. HSAs can be bought individually or, if your employer offers them, as an employee benefit.
Emergency fund: If you don’t have three to six months of living expenses set aside, your emergency fund should be at or near the top of your list. If you are near there, consider topping it up with your tax refund. Emergency funds should always be:
- Kept liquid but safe, not cash under the mattress)
- Set aside for specific emergencies. For example, job loss and unplanned medical expenses.
Going to Europe because you haven’t been since your honeymoon is not an emergency — it’s a goal to be saved for.
Needing $5,000 by 10 p.m. to bail your husband out of the poky may be an emergency.
Not being able to feed your family is an emergency. My point is that you should have a very narrow definition of what constitutes an emergency. In addition, I believe couples should have a rule requiring unanimous consent before using this money.
Debt relief: Do you owe money on a credit card(s)? Do you have a car or furniture loan that you are paying 5 percent or more on?
Before you spend that refund, consider paying down debt and cutting down on interest expense to get a guaranteed return on your money. You may be paying rates of 10 percent or more on your credit card debt and you’ll get an immediate return of the rate you’re paying. Can you do better than that anywhere else?
If so, be sure to let me know.
401k/SIMPLE retirement match: A rule for smart saving is to never miss a chance to get a 100 percent return on your money.
To state the obvious, your 401k/SIMPLE match at work guarantees to double your money instantly. If you’re afraid of the market, put your contribution into a money market fund. Not what I would recommend, but it gets the job done.
You may be wondering how to add to your 401k with a tax refund. First, you’ll need a sympathetic employer who will let you adjust your contribution. Increase your withholding to match the amount of your refund, using your refund to replace the extra withholding.
Easier than pie if you’ve ever tried to bake a pie before, but that’s a different column.
Charitable donation: If you’re feeling generous, helping out a charity is a great way to use your refund. In a sluggish economy, nonprofit organizations are the first to feel the pinch. Not only does it feel good to make a difference, but you also could qualify for a tax deduction. So don’t be an April fool. Treat your refund as an opportunity rather than a windfall, and you can benefit from your wise decision for years to come.
Johanna Fox Turner, CPA, CFP, RLP, is CEO of Milestones Financial Planning, LLC in May- field. She is president of Johanna Fox, CPA and publishes a free monthly financial news- letter (email email@example.com to subscribe). Contact Turner at jft@milestones- fp.com, 270-247-0555, 800-991-2721, or at www.milestonesfp.com.