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You're Getting a Tax Refund: Spend or Save?

Jan 30, 2017 3 min read Sheila Olson

Key Takeaways

  • Pay off your most drastic plastic.
  • Plug any holes in your protection.
  • Don't lend Uncle Sam another interest-free dime! Re-do your W-4.

 

If tax time has you smiling because you're getting a refund, you're not alone. According to the IRS, the average American got a check for about $3,100 in 2015—a nice windfall you can choose to spend or save.

 

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But if you're a recent college grad strapped with $30,000 in student loan debt (the average in 2016), your save-or-spend calculus changes a bit. So before you cash that check and treat yourself to a long-deferred purchase, check out these forward-thinking tax refund options to help reduce your financial anxiety and restore a little balance to your bottom line.

 

Give yourself a raise

The average tax refund works out to a little over $250 a month, money you're loaning Uncle Sam free of charge every year. Why not put that money back into your own monthly budget by adjusting your payroll withholding and deductions? For most student borrowers, that amount would cover most if not all of your monthly loan payment, freeing up income for retirement and emergency savings and even paying down debt. Since individual circumstances vary you may want to consult your tax advisor before adjusting your payroll withholding or deductions to ensure it is right for you.

 

Pay off high interest debt

Today's credit cards can carry interest rates of 18% or more--and paying them off gets you an automatic 18% return on your investment. That's exponentially better than you'll get tucking your refund into a savings account.

Look at it like this: If you make the minimum monthly payment on a $3,000 credit card balance at 18% interest, you may spend over $7,000 on interest by the time the debt is paid--and that's in addition to the original $3,000 you charged. Pay it off with your tax refund and you've saved yourself thousands for your own budget priorities.

 

Make an extra principal-only mortgage payment

If you're a new homeowner, that traditional 30-year mortgage can seem like a never-ending commitment. But you can cut your term by several years and save tens or even hundreds of thousand in interest by chipping away at your principal every year with a lump-sum payment.

If you have a $250,000 mortgage at 5.75% interest, you'll pay over $275,000 in interest over the life of the loan. By decreasing your principal $3,000 every year with your tax refund, however, you'll can possibly save over $85,000 in interest and pay off your loan almost nine years early.

 

Plug the holes in your insurance protection

When you're just getting started, it's easy to skimp on protection from life's worst-case scenarios in an effort to cut costs. That's not only a mistake when it comes to your peace of mind, it may leave you vulnerable to the type of financial catastrophe that can be impossible to overcome down the road.

  • If you rent, invest in a good renter's policy to cover you for liability in case someone gets hurt in your home. Make sure you've got enough coverage to protect all your possessions in the event of theft, fire, or water damage.
  • Review your car insurance liability limits coverage and your true exposure based on your income and assets--and upgrade if necessary.
  • Revisit any optional disability coverage you may have opted out from at work to see if the policy makes sense for you now.
  • Major life changes like engagement, marriage, new house or a new baby mean taking a look at your life insurance needs and possibly upping your coverage accordingly.

 

Prepay your vacation expenses

If you're just getting used to your budget, saving for a dream vacation is a daunting task--and it's no fun to go into debt over travel. Use your refund to prepay your airfare, hotel, and other expenses so you don't add to the cost of your trip by charging it on a credit card. As an extra bonus, you'll likely save money booking early and comparison shopping for the best travel deals.

 

What you can do next

Expecting a tax refund? Before you splurge (or save it), consider ways to spend the money and pay yourself forward.

Footnotes

Sheila Olson is a Charlotte-based freelance writer specializing in investing, personal finance, entrepreneurship, and retirement planning. She is a regular contributor at Investopedia and writes frequently for the banking and consumer credit industry.

 

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