Ask Kim
5 Smart Uses for Your Tax Refund
Use the influx of cash to improve your financial situation.
By Kimberly Lankford, Contributing Editor, Kiplinger's Personal Finance
March 4, 2010
I just filed my taxes and will be getting a pretty big refund. What’s the best way to use the money?
In a year when raises and bonuses at work are rare, getting a tax refund may be your one big chance to put extra money toward improving your financial situation. Here are five smart ways to use your refund:
Pay off high-interest credit-card debt. Many credit-card companies boosted interest rates in anticipation of the new credit-card law, so carrying a balance may now cost you more than it had in the past. And the new law requires card companies to clearly disclose how long it will take you to pay off that balance -- and how much you’ll pay in interest -- if you make only the minimum payment every month. Those numbers can be shocking.
Using your refund to pay off a balance with an 18% interest rate is like earning 18% on your investments -- an incredibly valuable use of the money. And if you pay off your balances, you can afford to close some cards that are now charging high fees. For more information about the new credit-card laws, see FAQs on the New Credit-Card Rules, More Credit-Card Fees Coming and Close a Credit-Card Account to Avoid Fees.
Rebuild your emergency fund. Many people had to raid their emergency fund over the past year and had little extra money to restore it. You could use your refund to start rebuilding that fund, which can help you avoid landing in credit-card debt if you have an emergency. Try to keep at least six months’ worth of essential expenses in this account, or more if you think your job -- or your spouse’s -- is in jeopardy. Keep the money easily accessible in a money-market account or savings account that earns interest. See Why You Need an Emergency Fund for more information.
Boost your retirement savings. You have until April 15, 2010, to contribute up to $5,000 to an IRA for 2009 (or $6,000 if age 50 or older). If your modified adjusted gross income is $120,000 or less if you’re single, or $176,000 or less if you’re married filing jointly, then you can contribute to a Roth IRA, which lets you withdraw the money tax-free in retirement.
If you earn too much for a Roth, you can contribute to a nondeductible traditional IRA, then immediately convert it to a Roth. See our Roth Conversions for Everyone special report for more information. If you’ve already made your 2009 contribution, put the refund money in your account for 2010 to jump-start your contributions. You can always add more money later in the year.
Build your college savings. It’s always hard to juggle saving for college and retirement. Here’s an opportunity to use your extra money to contribute to a 529 account. You’ll be able to use the money tax-free for college bills, and you could get a state income-tax deduction for your contribution. See The Best 529 College-Savings Plans for details.
Help your kid save for the future. If you’ve covered all of those bases, you can use the extra money to contribute to a Roth IRA for your child. Your kid is eligible as long as he or she has earned income for the year. Your child can contribute up to $5,000 or the amount of his or her earned income for the year, whichever is lower, and you can give him the cash to do it. The deadline for 2009 contributions is April 15, 2010. See Why Your Kids Need a Roth IRA for details.
Here’s something to consider: Wouldn’t it be better to have more money in each paycheck rather than wait for a refund? Use our Tax Withholding calculator to see whether you can adjust your withholding and get more money in each paycheck right away.
If you’re wondering where your refund check is, see How to Track the Status of Your Refund.
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Reader Comments (8)
Posted by: cjones at 03/04/2010 10:16:57 PM
My husband and I have filed our taxes "married filing seperately" since we first got married. We had a child in 2008 and had childcare expenses all of 2009. I attempted to prepare my taxes on-line but it wouldn't allow me to claim the childcare expense due to filing seperately. Why is that and is it possible to claim the expense filing seperately or MUST we file jointly?
Posted by: clydewolf at 03/05/2010 09:32:26 PM
Cjones, There are many reasons that may not allow a taxpayer to claim the Dependent Care Expenses. Most likely it is because you are filing separately, and you do not meet the requirements to be considered unmarried for tax purposes. Typically tax benefits are not designed for married filing separately. Most married folks benefit when they file their tax return Married Filing Jointly.
Posted by: CFrost at 03/07/2010 09:49:56 AM
We want to convert our IRAs to Roths but fear the 'automatic' tax assessment. Even though we have contributed to our IRAs over the past many years, it was only the first few years that we could claim the contributions. Since then we've been lucky enough to not qualify for pre-tax contributions. Additonally, we have alway claimed any reported gains. I worry that if we convert, the IRS will assume we owe taxes on the entire amout and I will not have any good way to prove otherwise. We are both over 60. Do we convert? How do we stay out of trouble?
Posted by: Mark at 03/07/2010 10:02:33 PM
Dear Kim, When calculating the area of a home office as a % of the total area of the home, should the total sq. ft of the home, include non finished areas such as a garage or only finished and temperature controlled area? I live in a 4 story row home with a total sq ft of approx. 2500 which includes the temperature controlled livable area and the garage. The garage is part of the building, about 340 sq. ft and is located next to the basement. The other part of the basement is a finished area where my office is located. When calculating the % of the home office area, should I divide the total area of the office by the 2500 sq ft or by 2160 (2500 less the 340)? Thank you
Posted by: JD at 03/08/2010 03:06:59 PM
...As if we haven't heard these recommendations a million times already. Face it, no one dumb enough to need this advice is going to find a Kiplinger article! And yet, the best refund use of all isn't mentioned - buy a printer, paper, and a stamp, and file a W-4 to reduce your withholding so you don't give Uncle Sam a loan until next April by getting a refund next year!
Posted by: Kim Lankford at 03/09/2010 06:17:21 PM
Hi JD, this is Kim Lankford., author of this article. Thanks for your comments. You're right about the refund -- if you did receive a big refund, it's much better to get that extra money in your paychecks rather than give Uncle Sam an interest-free loan again this year. I wrote about that in the second-to-last paragraph, along with a link to our tax withholding calculator, which shows how much you can add to your paychecks by adjusting your withholding and instructions for filing a revised W-4 with your employer. It's a great resource -- www.kiplinger.com/tools/withholding. Hope this helps.
Posted by: Lillie at 03/11/2010 09:02:30 AM
I have yet to file my taxes, I have done a rough draft so I am almost certain that I will get a refund that will provide me with some workable options, possibly paying off credit cards and rebuilding my emergency fund. You are so right! Many companies are cutting back on bonuses. Mine put a damper on the Christmas spirit last year by not giving bonuses and did so without informing us. Therefore, I plan to do use my refund even more wisely since more than likely the pattern will be repeated this year. The best part about the Credit CARD of 2009 is that creditors now post on your statements the amount of time it will take you to pay off your accounts if you are only making the minimum payments and how much sooner you can pay them off simply by increasing the amount. It has certainly been an incentive for me to get motivated to do so and I immediately thought of my tax refund as a primary option in accomplishing that goal.
Posted by: Jehnavi at 08/03/2010 06:09:24 AM
Your taxes need to be filed every year or you face a penalty. Remember, the IRS makes the rules so you going out and saying "I wont pa"y matters little. You will receive huge late fees and interest will build up on the balance you owe. At the end of the day you will OWE loads more cash then if you just payed what you owed and filled out your taxes. I guess you will show the authorities what's what. Then the IRS will RAKE YOUR BUTT over the coals in the end. Have fun! www.financeandmarkets.net