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Plan Smart Ways to Use Tax Refund

By Barb Wollan, Laura Sternweis

Is your tax refund the financial highlight of the year? Then it is a valuable resource – one you can use to get ahead, suggests Barb Wollan, a human sciences specialist with Iowa State University Extension and Outreach.

“A tax refund is once-a-year income, so I recommend considering the entire year ahead when deciding how to use it,” said Wollan, who specializes in family finance.

Anyone may receive a large refund if they have extra taxes withheld from their paychecks. However, the people most likely to receive refunds over $1,000 are younger families who benefit from the Child Tax Credit, and especially lower or moderate-income young families who receive the Earned Income Credit because they have a qualifying child, Wollan noted.

For families who have sufficient income to meet their needs throughout the year, Wollan suggests that a great use for tax refund money is to save or invest it – perhaps in college or retirement funds, or for emergencies, or for major goals like buying a house or a car.

“If you think of tax refunds as ‘bonus’ money, you can set aside half of it, or more, to meet goals and boost your net worth without feeling any pinch in your budget,” Wollan said.

For example, adding $500 per year to a retirement account between ages 25 and 45 would result in over $43,000 extra in that account by age 65, assuming an annual return of 5%.

For those who occasionally find themselves short on funds throughout the year, Wollan offers two elements of yearly planning:

  • Think ahead to needs and wants that will arise seasonally; she gives examples such as extra child care costs during the school’s summer vacation, back-to-school costs, semi-annual car insurance premiums and annual vehicle registration fees.
  • Consider major expenses that might occur in the coming year, such as new tires for the car or predictable home repairs.

“My observation is that people typically prioritize paying off any past-due bills,” Wollan noted, “and I agree that is generally a wise step, since these bills often involve late fees and high interest rates and may even put family safety in jeopardy if utility shut-offs are a possible threat.”

Wollan pointed out that those past-due bills often are the result of large seasonal expenses. For example, people may get behind on paying utilities, day care or other bills when they encounter back-to-school expenses in the fall.

“When people set aside a chunk of their tax refund for expenses that may arise in summer or fall, they can avoid being in the hole when tax season rolls around again next year. That, in turn, reduces total costs since there would be no late fees and extra interest charges. This simple act of looking ahead can dramatically improve a family’s financial stability and reduce stress levels year-round,” Wollan said.

“Many families like to ‘splurge’ a little with their tax refund – perhaps on eating out or going to a special concert or doing something else a little frivolous, especially since during the rest of the year there may not be any extra to splurge with. There is nothing wrong with that, if families have considered all their options,” said Wollan.

“When it comes to tax refunds, I encourage families to use at least a portion of this once-a-year income in a way that will help them get ahead in the long run,” Wollan said.

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