Remember the 3 S’s: Save, Splurge & Shrink
It’s tax season. And while that isn’t many people’s idea of fun, for some it does come with a nice surprise at the end: a tax refund
A tax refund, especially if it is sizable, can help you accomplish personal or financial goals. How? Three ways: saving, splurging and shrinking (your debts).
Let’s look at each.
SAVE
Saving might be a “boring” option, but it’s often the one that gives you the most flexibility and peace of mind long after tax season ends.
It also can take many forms. You could be saving for:
- A fully funded emergency fund.
- Retirement.
- A future vacation.
- A major purchase.
Setting the money aside can help you move toward these goals. How you should set that money aside largely depends on a number of factors.
A good starting point is asking yourself when you might need the money.
If it is for an emergency fund, the best option might be a savings account that allows you to accrue interest without risking penalties if you need to withdraw it.
If you are confident that you won’t need to access the money for three or more months, check on the rates for various certificates of deposit, or CDs. There are penalties for early withdrawal, but they can earn you a higher interest rate than your standard savings account.
If you are saving for retirement, an IRA offers tax advantages. What kind of tax advantages depend upon what kind of IRA you get.
With a traditional IRA, the money is pre-tax (and thus the amount you contribute likely will be deductible on your taxes). You only pay taxes on it when you begin withdrawing the money.
With a Roth IRA, the money is post-tax, but you aren’t taxed on any gains when you begin withdrawing from the account.
SPLURGE
Splurging might not be a concept you’d expect to see promoted by a credit union. But when done thoughtfully, it can improve your quality of life without putting your finances at risk.
A smart splurge isn’t about impulse spending. It’s about using a one-time refund to reduce the long-term cost of something you already planned to purchase.
Two of the most common larger expenses are:
- A new or used vehicle, where a larger down payment can lower your monthly payments going forward.
- Home improvement projects that improve the comfort, efficiency or value of your house.
Unless your tax refund is massive (or it is a relatively small home improvement project), it probably won’t cover the entire expense. It could, however, be paired with an auto loan or a home improvement loan to cover the rest of the cost.
Always look at the tax refund as a down payment, however, rather than a means to afford the amount due for the first month. Don’t fall into the trap of letting a one-time payment convince you to take on an ongoing expense that you can’t afford once the refund runs out.
Working with a local lender like UNITE Credit Union can help you understand your numbers before you fall in love with a home that is out of your budget.
SHRINK
Using your tax refund to shrink your debts can be a great financial decision, especially if you are carrying high-interest credit card debt.
Reducing high-interest debt can free up cash flow every month, long after your refund is gone.
A good rule of thumb is to look at your debts and see which has the highest interest rate and put the money toward that. If you pay it off completely and still have part of the refund left, move on to the next highest rate.
If the loan is of the lower-interest variety, however, a caveat comes into play. Before putting every dollar toward debt, make sure you have at least a small emergency cushion. Putting it all toward paying down an auto loan charging 5% interest might hurt you financially if it causes you to take on debt on a credit card charging in excess of 20%.
What Do YOU Want To Do With Your Tax Refund?
If you have any questions about what CD, savings or loan products available from UNITE, call us to talk to one of our representatives. If you are unsure or want someone with whom you can talk through your financial situation, we also offer financial counseling services.