Ideas for How to Spend Your Tax Refund
By EILEEN ALT POWELL, AP Business Writer
NEW YORK - A lot of Americans think of their tax refunds as "found money," similar to a windfall they'd get by winning a lottery or being named in the will of a long-lost relative.
That attitude, however, can lead to extravagant spending.
"We call it 'mental accounting,' and it's a process by which we treat money differently based on where it came from or where it's held," said John Nersesian, a managing director with Nuveen Investments in Chicago.
Tax refunds, in reality, are simply a return of the wages that were withheld through the year. So consumers "should treat them the same as wages" when they make their spending and savings decisions, he suggested.
So far this year, four out of every five taxpayers have claimed refunds, with checks averaging $2,128, the Internal Revenue Service (news - web sites) says.
Here are some ideas from financial experts on how consumers can put that money to good use:
Pay down debt
With interest rates on credit card debt averaging about 13 percent, paying down balances is a good use of tax refund money, said Greg McBride, a financial analyst with Bankrate.com.
A cardholder who applies $1,000 of his or her refund to reduce a $9,000 credit card balance carrying that rate will save more than $450 in interest costs, McBride said.
"That's not a bad return on that $1,000, is it?" he said.
Set up an emergency account
Most people know they should set aside enough money to cover three to six months of living expenses if they lose a job or face an emergency. But many don't do it, or hesitate because the earnings on savings accounts and money market mutual funds are so low.
McBride offers a different rationale. An emergency fund, he said, "serves as a buffer from incurring debt to meet unexpected financial demands."
In other words, save now and don't pay 13 percent interest later.
Save for your future
Nuveen's Nersesian notes that most Americans haven't saved enough for retirement.
That means that opening a traditional Individual Retirement Account or a Roth IRA could be a good use of refund money.
"The Roth deserves first consideration," he said. That's because income limits are higher than for the traditional accounts, and earnings are tax-free forever, he said.
Save for your kids' future
Section 529 college savings plans — which get their name from a section of the tax code — allow parents to save for their child's college education in state-sponsored plans.
Nersesian notes that some states give parents a tax break when they put money into the accounts. Section 529 savings grow tax-deferred, and withdrawals may be exempt from both federal and states taxes when used for approved educational purposes.
"With college costs still rising fast, saving should be a priority," Nersesian said.
Invest with tax efficiency in mind
Fred Grant, a senior tax analyst at TurboTax, noted that the maximum tax rate on dividends has been cut to 15 percent. That makes putting money into stocks and mutual funds that pay qualified dividends "certainly worth consideration" for people with surplus funds.
There are other investments, too, that can pay off at tax time next year, he added.
"If you're a small business owner, you can spend the (refund) money on equipment, like a computer, that generates a tax deduction," Grant said.
Give some to a nonprofit
A survey of 1,800 taxpayers by TurboTax found that some intend to donate their tax refunds to charity.
"If you're planning to do it in December, why not do it now?" Grant said. "It's also a good tax-saving idea, provided you're able to itemize."
Taxpayers who get big refunds obviously are having too much money withheld by their employers, essentially giving the government free use of their money for a year. They can reduce the withholding by filing an amended IRS Form W-4 with their employers.
But, as Grant points out: "I've talked to people who like and look forward to that refund — it is a bit of a forced savings plan."
While he endorses paying down debt and increasing savings, he also thinks it doesn't hurt for people to spend some of their refund money just for fun.
"There's that old saying about 'all work and no play,' you know," he said.
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