6 Prudent Uses for your Tax Refund This Year

Now that tax day is finally behind us (well, except for the uber-procrastinators), the next consideration is what to do with that tax refund check.  First of all, I hope people didn’t take their tax preparer up on the offer to get a rapid refund at exorbitant rates.  As outlined here, it’s a total ripoff.  But down to business.  There’s no worse feeling than looking back and regretting that fact that you squandered an opportunity to do something good.  Here are 6 ideas for what you can do with that tax refund.

1. Pay Down Debt – Depending on the type of debt, this may very well be your most prudent use of funds.  If you’re carrying credit card debt at 20%+, these are after-tax dollars that you owe at an exorbitant rate.  Rather than taking a $4,000 refund and buying the latest plasma screen or hitting the Caribbean, you can effectively clear a 30% return on investment (if you consider this in that context) on a pre-tax basis.  If you’re carrying student loans or some other burden that you want to get off your back, the interest rate may very well justify paying it down.  Now, with mortgage rates at record lows and going to as low as perhaps 4.2% as predicted here, I don’t advocate pre-paying mortgage interest at these rates.  With the mortgage deduction, you’re looking at an effective interest rate of less than 4%.
2. Invest in home or business projects with a positive return on investment – This may be anything from insulating your house to buying that new energy efficient water heater.  While the payback period may not be instantaneous, when considering the fact that 2009 allows for certain tax write-offs for energy efficiency projects, this is a good year to consider such endeavors.
3. Refinance! – On a similar note, refinancing now at these incredible rates yields a substantial return on investment.  As this net present value model shows, while you may need a couple years to break even on the investment, you might enrich yourself to the tune of tens of thousands of dollars in present day dollars by simply refinancing into a lower rate, fixed mortgage (and this includes the fees and expenses required up front!).  When in doubt, use a Net Present Value model to see which mortgage option yields the highest NPV when confronted with multiple options.
4. Various New Investment Options – Rather than just throwing the money in the checking account or contributing to your conventional investment vehicle (be it trading or upping your 401K contributions), start that new account that you’ve been putting off.  Perhaps you have a 3 year old child and haven’t yet started a 529 plan (which I recommend over an ESA).  Some states allow you to deduct the amount invested into a 529 plan from your state taxes which is a benefit above and beyond the tax-protection provided by the 529.  Imagine, a guaranteed say, 7% return on your investment (OK, at next tax rebate, so discounted back, perhaps it’s still 4-5% or so) above and beyond what you even earn on your underlying investment.  If the market does actually revert back to historical norms and returns 9% per year during your childs’ next 15 years, imagine that compounded 15% return – unbeatable!  If you don’t have children, consider starting a Roth IRA, which provides different flexibility, benefits, and likely, investment options compared to your company 401K or equivalent.  In retirement, you’ll appreciate the fact that you have two different types of accounts you can tap.  Depending on your income and tax bracket, tapping one or the other first may be advantageous over the other.
5. Build your Emergency Fund – There’s nothing worse than finding out your family’s facing a financial crisis and you don’t have the means to handle it.  This could range from anything from a layoff or major uninsured loss to a medical emergency or legal punitive damages.  Anything can happen and by being prepared with at least a few thousand dollars in an emergency fund, you will have that much more buffer to protect you from missed mortgage payments, credit damage, foreclosure, or whatever results in your losing sleep at night.
6. Enjoy Life – If you’ve already accomplished #1-5, you’re secure with your finances and spending, and you have some excess rebate funds left over, take a portion of your rebate and do something special for yourself, for your spouse or for your kids.  Do something you don’t do every year, something memorable.  It might just be a weekend getaway at a bed and breakfast or a skydiving trip with your kid.  When you’re looking back on life, you’ll have those fond memories to look back on rather than smiling saying “I’m glad I’m on life support with an estate valued at $7.504Million instead of a measly $7.500Million right now”.

Remember, this is probably money that you hadn’t budgeted or counted on.  While you effectively gave the government an interest free loan last year, you now have some excess funds.  But live by this and you’ll never go wrong: Everything in Moderation.

What are you doing with your tax refund dollars this year?

Tagged as: Tax Refund