There is no law that says Americans HAVE to spend their
returns -- but too many of us act like we do.
There is a better use for that money, as two tax specialists
point out.
Margaret Van Brunt, assistant dean of the Rohrer College of Business at Rowan University, and
Rick Marmon, associate professor of accounting and finance, both certified
public accountants, estimate that 75 percent of taxpayers get a refund,
which in 2005 averaged more than $2,000. “A cash windfall like this, of course,
has Americans across the country struggling with tough decisions, like whether
they should buy the plasma TV or book that last-minute cruise. As tempting as
it may be, consumers would be far better off resisting the temptation,” Van Brunt
says.
Van Brunt and Marmon have a better idea on what to do with your tax
refund -- actually, they have five of them:
1) Avoid the refund-anticipation loan. Don’t borrow against your
expected refund. Despite numerous warnings by consumer-watchdog groups and
reams of bad press, refund-anticipation loans — which allow taxpayers to borrow
against their expected refund — continue to be a popular waste of money. The
appeal of these loans is that they deliver cash in a day or two, via a tax
preparer, who's repaid when the real refund arrives. The problem with these
loans is that they don't come cheap. Typically, borrowers pay about $30 to $165
(costs vary, in part, by the loan amount) for what typically turns out to be
roughly a 10-day loan. The cost usually includes administrative fees as well as
interest charges, which can be downright usurious. That's not the only problem.
If, for some reason, the refund is held up or denied by the IRS, you still owe
on the loan.
”We advise not to shrink refunds before they even arrive. For those with
a real need for fast cash, a better option is simply to file electronically and
have the refund deposited directly into a checking or savings account. Opting
for this faster treatment has no cost and should deliver the refund in about 10
business days, rather than the four to six weeks it takes via snail mail,” says
Marmon.
Some people take out a refund-anticipation loan as a means of paying for
their tax preparation. The tax preparers encourage this by allowing the
taxpayer to deduct the cost of preparation from their refund-anticipation loan.
(In other words, the loan includes the cost of the tax preparation, which is
then covered when the refund arrives.) But these days, just about anyone can
file his or her tax returns for free online through the IRS Web site.
2) Save your refund. Everyone should have a bit of extra cushion in his
or her budget in case of the unexpected, such a job loss, illness or injury. A
tax refund can help build that cushion. An emergency fund should consist of
three to six months' worth of living expenses held in a cash account like a
money-market fund. Unfortunately, with interest rates so low, people earn next
to nothing on their money. But just knowing it's there can be a source of
comfort when times get tough.
3) Contribute to an IRA. If you invested a refund in a tax-deferred
account earning 8 percent annually, you could double your money in less than 10
years.
And an IRA — particularly a Roth IRA — is a great way to do it. With a
Roth, there isn't any sort of upfront tax break (like there is with a
tax-deductible IRA), but qualified withdrawals taken after age 59 1/2 are
completely tax free. Van Brunt and Marmon recommend giving up the deduction and
going for the Roth — which is all yours for the rest of your life. You don't
have to share it with anybody. And remember: There's still time to make a 2006
contribution (the deadline is April 17), as well as one for 2007.
4) Pay off debt. These days, the average household with at least one
credit card is carrying more than $9,200 in credit-card debt, according to
CardWeb.com. Tackling high-interest credit-card debt is one of the smartest
ways to use a tax refund, and doing so provides an immediate return on
investment. (And most likely at rates that would be difficult to duplicate in
today's stock market.)
5) Consider your children. If college costs continue to rise at their
current pace, four years at a private college 18 years from now could cost more
than $320,000. Needless to say, people with children need to start saving
early. Using a refund to contribute to a 529 College Savings Plan or a
Coverdell Education Savings Account is a great way to do it.
Both of these accounts offer tax-free withdrawals for qualified college
costs. With a Coverdell Education Savings Account, annual contributions are
limited to $2,000 (per beneficiary), and income limits do apply. The beauty of
a Coverdell Education Savings Account, however, is that, like an IRA, you can
invest funds any way you like.
Good ideas all -- and certainly better than buying that racing boat or
that Aspen time
share you've had your eye on.