Monday, March 1, 2010

How can I save as much of my tax refund as possible?

A great question from one of my formspring followers:
As one of the fortunate folks who MAY be getting a refund, what tips would you suggest to save as much as one can of said refund?

I can't say this enough to people: getting a refund only means you've paid the government more than you should have all year long. They take that money, use it for other stuff and give it back to you months later with no interest. Great deal for them, sucks for you.

Were I you, I'd readjust my withholding to make sure you're only paying what you should and hold onto more money throughout the year. That's a better way to save because you'd get that full year to earn interest on all that money rather than getting it all at once having received no interest from the government at all.

But that won't solve the dilemma of how to save the refund you already have coming. My advice would be to start wherever you can get the biggest return. Often that's by paying down debt as opposed to putting the money into checking, savings or investments. Sounds
counter intuitive but it's not.

Think about it: if you have a credit card balance that you're paying 18 percent interest on, you save more -- at least in the short term -- by paying that balance down or off than you would by putting the same amount of cash into an account or investment that returns you five percent.

If you have no credit card debt, then look to beef up your emergency savings. You should have at least three months' worth of living expenses stashed away in cash somewhere (and by somewhere I don't mean under a mattress).

If you've done both of those things, you're in great shape and might want to try this little trick that would help you save AND reduce your tax burden for next year. Open an IRA or contribute to the one you currently have by putting the money you got from this year's tax refund into that account.

When next year's taxes come around, some of that money that you put in might be tax deductible, as is the case with many IRA contributions. Check with your financial adviser of the bank handling your IRA to be sure of the rules and exact tax ramifications. Good luck.

image: Viola Joyner/

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