March 5, 2020
Tax season is fast approaching, meaning many of you are shaping up to get a sizable income tax refund. Tax refunds generally feel like a windfall, and oftentimes the money is already spent in our heads before we even receive them.
But what is the best course of action to do when you receive a sizable sum of money? We interviewed several experts to get their advice.
Gary Milkwick – Chief Product Officer at 1800Accountant.com
“When people ask me what I should do with their tax refund, coming from an accountant’s perspective, I tell them you can actually contribute to a traditional IRA in 2020, so you can declare that on your 2019 tax return and as long as you contribute the money by April 15th, 2020, you get a tax deduction for it.
If you have high-interest credit cards, paying it off is a great use of funds because a lot of people have trouble catching up, paying those credit cards off.
I think it also important to put at least a portion of it towards savings. The eventual goal is to have enough saved up to not have to work for a year if something happens, but you want to have at least 3 to 6 months saved.
If you have kids, you can put it into a 529 plan. A lot of states will give you a tax deduction that helps you pay for your kids’ college.
It is tough to prioritize what exactly you should spend your refund on, because it depends on people’s situations, but all of these options are a better idea than just spending the money.”
Janet Berry-Johnson – CPA and MoneyCrashers Contributor
“The first thing you should do when you receive a tax refund is consider whether you need to adjust your withholding. Getting some money back is ok, but a large tax refund means you’re giving the federal government an interest-free loan instead of saving money or using it to pay your bills.
To change your withholding, you need to complete a new Form W-4 and give it to your employer’s HR or payroll department. The IRS has a Tax Withholding Estimator if you need help figuring out how much tax to have withheld.
Next, if you don’t have an emergency fund, starting one is a smart way to use your tax refund. Without an emergency fund, most people wind up using credit cards for things like unexpected home or car repairs or medical bills. With the high-interest rates on most credit cards, using them as an emergency fund can turn a one-time expense into months or years of paying off debt. Most financial experts recommend saving three to six months’ worth of expenses in an emergency fund, but if that sounds impossible, try saving $1,000 to start.
If you already have a fully-funded emergency fund but are carrying a balance on any high-interest debt like credit cards, use your tax refund to pay off (or pay down) those balances.
This can help you save money on interest payments and improve your credit score by reducing your credit utilization ratio.”
Eric Rosenberg – Business Insider Contributor/Founder PersonalProfitability.com
“The first thing I would do is pay off high credit card debt.
You are already used to living without the money and it is already not part of your budget, so you should not just take it and spend it on regular purchases.
It is important to use a tax refund to improve your finances if you are able to. If you don’t have debt it’s a good idea to save and invest that money.
If you don’t have any high-interest debt but have outstanding car or student loans, those are good places to focus the money because it can get you closer to your payoff and save you money on interest.
If you don’t have debt at all, high five! You should definitely find ways to save and invest for the future. If you don’t have a Traditional IRA or Roth IRA, those are good places to start.
If you have already reached the maximum for retirement, you can put it in an investment account and pick stocks or funds that align with your long term goals.”
Ryan Alling – Financial Advisor, Wedbush Securities
“If any high-interest debt is outstanding, it must be paid off ASAP because it compounds monthly and is severely detrimental to your financial freedom. Paying high-interest debt off–such as credit card debt–guarantees a return equal to that of the interest rate you were paying your creditor.
If your emergency fund is too small it will give you peace of mind to add your tax return to your emergency fund. Emergency fund sizes will vary based on expenses and the number of dependents, but in general it should be at least 3-4 months of expenses.
Fund an IRA: everyone wants to live life on their own terms when they retire but not everyone takes the actions necessary to do so. Start by funding your IRA.
Open an investment account if you don’t already have one: enable your money work for you by investing in mutual funds, ETFs or individual securities. Consult your financial advisor to see which option is most sensible for your unique goals, time horizon, and financial situation.
Increase your home equity: give yourself more peace of mind and less debt on your personal balance sheet.
Fund your children’s higher education: costs are higher than ever and perpetually increasing so the sooner you start the better!
Start a side business: the internet has enabled adolescents with creativity, courage, and ingenuity to make millions of dollars online. What do they have that you don’t have? Write down 1-2 business ideas a day until a feasible one surfaces.
Attend a personal growth seminar or take a class: make yourself a more valuable asset in the marketplace by polishing your sales, public speaking, and leadership skills. You are your best asset and your value is directly proportional to your income.
Make a donation: help your fellow humans and potentially receive a donation deduction on next year’s taxes
Have some fun: life is simply too short to not do what you want to do. Frugality is very important when it comes to building wealth but there must be a balance between frugality and the freedom to enjoy yourself.
As financial advisors, we frequently see clients sit on their nest egg and let their wealth compound without enjoying the fruits of their labor and discipline. Money is freedom–or whatever else you want it to be–and we encourage our clients to not only build wealth, but also utilize their hard-earned wealth to do what makes them happy. “
Brian Hershman – Founder Buck Stops Here Accounting
“From an accounting perspective, you would be surprised how many people don’t own savings accounts.
Use this as an opportunity to open one. Another tip is to make the savings account hard for you to access, have it be at a separate bank that is not linked to your checking account.
People that are good with money use ratios. Before they make money, they know what they are going to do with it.
A good ratio to come up with is to try to save at least 10 percent. As long as there is a set percentage in mind, that is a good start. You should also be operating this way with your paycheck, not just your refund.
For example, If you make $100, you have percentages that determine how you allocate the money.
The first rule is to pay yourself first, meaning immediately set money aside to put into your savings.
Then, some people like to give 5 percent to charity. Maybe a percentage to retirement, that way it is siphoned off into different buckets. Maybe one that is allocated to travel or to reward yourself.
Pay yourself first with a percentage and then start attacking the debt. Here’s how you do that: some people like gaining momentum by focusing on smaller debt and getting small wins.
Another good allocation would be to use the money to start a side business through an LLC or S Corporation to invest in starting another stream of income and potentially save money on taxes.”
Craig X. Cecilio, Founder & CEO of DiversyFund
“Most Americans see their tax refund as free money, but it’s money that has been theirs all along!
When you see your refund as a bonus, it’s easy to spend it all on a vacation, new furniture, new clothes, or a down payment on a new car.
This year, think about your refund as money that should have been working for you already. For the last twelve months, the U.S. Treasury has been putting your money to work interest-free. What a deal for them!
One way to catch up is to invest your refund towards your future goals.
At DiversyFund, we’ve created a platform that allows people to diversify their portfolio into alternatives that everyday Americans have not had access to before. These investments allow people to allocate towards their long term plans and hedge against market volatility. For those getting a refund, consider allocating a portion of it into alternatives, just like our fund, the DiversyFund Growth REIT which focuses on multifamily real estate.”