Now that April 15 is upon us, many will be finalizing and filing their tax returns while others will be asking for extensions. For those planners out there, have you considered what you are going to do with your tax refund?
I spoke with Philadelphia-based personal finance expert and author of Life & Money, Sheila Jacobs, to get her take on tax season.
According to Jacobs, "Getting a tax refund may seem like fair reward for a year of hard work and the trauma of the tax filing process, but the refund is not a reward at all." She said, "It is, as the name indicates, a refund that you have worked hard for throughout the year. And, like all other income, it should be allocated to the financial goals that you have set for the year."
So, I asked, "What if you have not determined your financial goals?"
Jacobs replied, "Then step one is to set some goals for 2010 before spending your tax refund monies. Step two is to allocate accordingly." One goal, she said, should be to keep more of what you have earned.
Jacobs advises individuals to avoid expensive refund anticipation loans. She explained that some tax preparation services offer "refund anticipation loans" or instant refunds. They prepare your taxes and give you your anticipated refund amount on the spot. She also explained that you can get a refund almost as quickly by e-filing and using direct deposit. Plus, you won't have to pay interest (sometimes rates are as high as 50 percent on a refund anticipation loan).
A recent ABC news report details some of the issues surrounding tax refund anticipation loans and related tax filing fees.
I also spoke to William "Bill" C. Briggs, CPA, who is the head of the Philadelphia tax department of Citrin Cooperman. Briggs also said that planning is the key to financial success. He explained that there are a few ways to invest your tax refund to save money in the future and to create a bigger refund for next year.
For example, Briggs talked about the energy tax credit. According to the U.S. Department of Energy Web site, if you purchase an eligible energy-efficient product or renewable energy system for your home, you may be eligible for a federal tax credit of 30 percent of the cost, up to a total credit of $1,500. Those products must be placed in service between January 1, 2009 and December 31, 2010. Briggs said, "If you need to replace your stove, roof, insulation, water heater, HVAC, or windows and doors, consider investing your tax refund monies in energy-efficient or renewable energy products." According to Briggs, "They will not only save you money on your energy bills, but also on your 2010 tax returns."
The second tip Jacobs provides is an idea for making next tax season less stressful. Jacobs said, "If you are about to deliver a disorganized box of jumbled receipts and papers to your accountant, now is the time to create a personal financial filing system. De-clutter and organize personal financial information. Getting organized can also help you save tax preparation costs. You can't expect a tax preparer to clean up your clutter for free."
For the small business owner, Briggs advises that you should inventory your business equipment. If something is in need of replacement, investing this year's tax refund can help you for next year. He explained that as a small business owner, you can write off 100 percent of the cost in 2010 instead of taking the depreciation deduction over five to seven years.
For individuals and business owners focused on debt reduction, Jacobs said that your refund might provide a good opportunity to move closer toward minimizing liabilities. Briggs agreed. According to Jacobs, you can start by using your tax refund to pay down credit cards, student loans or other debt.
She advised individuals to get into the habit of paying off their highest interest rate debt first. "But, if you have a few small low interest rate bills out there, it is okay to pay those off if it gives you peace of mind, " she said. A pattern of paying off higher debt first will save a lot of money over the long term.
If debt reduction is not your primary goal, revisit your other 2010 financial goals so you can use the refund to get or stay on track.
For those fortunate enough to be making retirement plan contributions, Jacobs said, "Consider making your 2010 contribution early. There is no rule that mandates waiting until the end of the year. By getting into the habit of contributing early, your money will have more time to work for you." This year in particular, there are still a lot of investments that are valued far below levels of a few years ago, so talk to your tax and financial advisors and take advantage of some bargains.
Briggs also encourages individuals to consider opening or contributing to Roth IRAs and 529s (for those with school-aged children). Another way to put your tax refund to good use, he said, is to "consider using the refund for living expenses while increasing the percentage of your 401K contribution." These are longer-term, tax-free investments.
No matter what your goals, Jacob suggests that individuals make sure to have some money set aside for emergencies. If you are just getting around to financial planning for 2010, make an emergency fund one of your priorities.
I asked Jacobs how much people should put away for emergencies. She said that the best case scenario is to put away the equivalent of 12 months of your monthly expenses. She also said that six months should be the minimum for liquid finances in an emergency account.
Finally, Jacobs encourages people who have worked hard all year to splurge a little bit. She said, "Take 10 percent or less of your refund and reward yourself for a job well done in a tough year."
Now, that is advice I like.