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The Money Prof
Tuesday, April 1 2014
What should I do with my income tax refund?Are you getting a Federal and/or State income tax refund? If so, have you decided what you will do with the money?
Some folks do not take it, but use it as a credit for their 2014 Income taxes. That may be comforting to know that you have some cushion for next year, but it may not be your best strategy. For one thing, you are giving an interest free loan to the government and giving up the opportunity of investing the funds yourself. Sometimes a bigger paycheck during the year, can help out, though knowing one is getting a refund can be psychologically rewarding as well.
Let's assume you will take the refund(s). There are several avenues you can take with the cash. Spending the money is the first option that comes to mind. Buying that computer, television, or furniture that you always wanted. Using the refund to take a vacation is a common use for the funds. Another use for the funds is to build emergency reserves. We all need some level of liquidity.
I would suggest that before you randomly spend the money, broader consideration should be given. The refund, like any other source of funds received, should result in improving your quality of life over the long run, not just the near-term. I have written about financial planning, quality of life and cash as a means to fulfillment. The bigger picture is what will make you happy in the years ahead. Reaching goals, good health, good friends and family are the important things in life. The question then is asked, how can my refund make me happy in the long run. This leads us to another option: saving and investing. You can take the refund and apply it to the investment that will help you attain your goals Another option is debt reduction. This especially becomes important if your net interest cost (after taxes) is higher than the net return you can earn on your income tax refund.
If you find yourself with large income tax refunds, then you possibly are withholding too much from your paycheck. By claiming more exemptions or having your employer take out less withholding, your paycheck will be higher on payday. The increase in cash flow could be beneficial to you. If an income tax refund was a one-time event, then it may not be as important to plan for it. Since, paying taxes is an annual activity, careful assessment of your taxes and refunds are desirable.
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