February 27, 2009
More and more Americans are filing, and paying, their taxes electronically. The IRS projects the number of individual tax returns filed electronically in 2009 to exceed last year's record of nearly 90 million taxpayers.
On the flip side, they'll also receive any tax refunds electronically as well, which dramatically speeds up the process. But before you rush out and spend your refund on the latest gadget, check out these recession-smart ways to invest it:
Pay down debt. This strategy will have the most pronounced impact on your financial well-being because the interest you carry forward month after month can significantly magnify the cost of the money borrowed.
For example, suppose you carry a $1,000 balance on a credit card with 18 percent interest and you're only making the minimum monthly payment ($40, assuming a 4 percent minimum payment). Even with no additional purchases made, it will take more than seven years to pay off the balance and cost an extra $516 in interest. Simply doubling your monthly payment to $80 could cut the payoff time in half and lower the interest paid to $216.
Save for emergencies. Even in the best of times, financial planners recommend socking away at least three to six months of living expenses in easily accessible savings in case of job loss or other unexpected emergency. If you don't already have a savings account, use part of your refund to open one and have money automatically deposited from each paycheck. Because regular savings accounts currently offer very low interest rates, you may want to shop for a higher-yield money market savings account or short-term CD at a site like www.bankrate.com.
Save for the future. With so many pressing needs today, it's easy to overlook the importance of saving for tomorrow. If your debt and emergency savings are under control, consider stashing at least part of your refund in an IRA or 401(k) plan, particularly if your employer matches employee 401(k) contributions, since that's like getting free money.
Practical Money Skills for Life, Visa Inc.'s free personal financial management site, contains detailed retirement financial planning information such as how 401(k) plans work, tax ramifications and interactive retirement savings calculators (www.practicalmoneyskills.com/401k).
Invest in yourself. We've all seen how quickly jobs – and whole companies – can become obsolete and disappear. Make sure you have additional skills to fall back on and boost your earnings potential by enrolling in college courses or vocational training. See if your employer will help pay for job-related education.
Invest in your family's future. Another good use for your refund is to set up a 529 Qualified State Tuition Plan or a Coverdell Education Savings Account to fund your children's or grandchildren's education – all while lowering your tax bill. Visit the websites of the U.S. Securities and Exchange Commission (www.sec.gov/investor/pubs/intro529.htm) and the IRS (www.irs.gov/taxtopics/tc310.html) for information.
Avoid getting a tax refund in the first place. By having too much tax withheld, you're just giving the government an interest-free loan – money you could use to pay down your own interest owed throughout the year. Ask for a new W-4 form at work and recalculate how much is being deducted each pay period. Your goal should be to receive little or no refund.
One last suggestion: Spend part of your refund on a session with a financial planner who can help you map out a long-term financial strategy. If you don't know one, www.plannersearch.org is a good place to start your search.
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