The average tax refund last year was around $1,800. This means that many taxpayers are over-paying their taxes by a significant amount. Some people think of a tax refund as a gift from the government. They feel this money should be spent on something special or frivolous. Below are four "not so frivolous" suggestions for your refund:
First, pay off high interest credit cards. These are the greatest threat to your financial well-being. If you are like the average consumer, you probably have a number of creditors. Pick the debt with the highest interest rate, or choose any credit card that charges interest based on a two-cycle average daily balance, and use your tax refund to pay it off.
Second, create an emergency fund. While Americans have spent the last decade spending, we haven't been saving. According to the U.S. Department of Commerce, the savings rate in 2000 was -0.1%, the lowest level since the Depression. There are several theories on how much you need in an emergency account. If your job is one where you might expect layoffs or downsizing, then you need to have more set aside. Think about how long it will take you to find a new job. How long could you survive financially on your current savings? Having from 3 to 6 months' living expenses in savings is a good idea. Your tax return will get you there faster.
Third, save for retirement. That $1,800 is just $200 short of funding an IRA for the year 2001 (starting in 2002, the contribution limit increases to $3,000). That $2,000 per year is your ticket to a million dollars if you start early enough. If you're 25 and you earn an average 10% return, the $80,000 (40 years x $2,000) that you save will turn into a million dollars for your retirement.
Fourth, adjust your tax withholding so you won't get a large refund again next year. "What," you say, "give up my tax refund?" In essence, when you get a tax refund, you have loaned $1,800 to the government without interest. Instead, adjust your W-4 with your employer for the best fit in terms of exemptions. You probably would not even think of lending money to an acquaintance without demanding some interest as compensation. Why should your tax withholding be any different?
For additional information about how to invest your tax refund, check the Rutgers Cooperative Extension online home study course, Investing For Your Future, at www.investing.rutgers.edu. The course was recently revised to include 2001 tax law changes. Print copies of the course are available at county Rutgers Cooperative Extension offices for $15.
This message is sponsored by Rutgers Cooperative Extension. For further information about available educational programs and other services, contact your local Rutgers Cooperative Extension office.