Tens of millions of Americans have already received tax refunds – and millions more will cash checks before tax season is over.
While recipients are usually happy that they have extra money, a tax refund is a lousy deal. Instead of thinking about the money as a windfall, Buzz-Kill Jill is here to tell you that you just made an interest-free loan to Uncle Sam!
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To make sure that you don’t repeat the refund next year, go to IRS.gov and use the withholding estimator tool and then adjust your withholding at your employer or if you are self-employed, consider reducing your quarterly tax payments. Once you have addressed the refund issue, the next question is: What are you going to do with your refund?
Start with your ‘Big 3’
(1) Fund an emergency reserve that can cover 6-12 months of living expenses
(2) Reduce credit card or other high interest debt
(3) Fund retirement plans to the best of your ability, especially if you have an employer match
Consider a Traditional or Roth IRA
The limit for 2024 is $7,000 for those under the age of 50, with an additional $1,000 if you are over 50. The difference between a Roth and Traditional is WHEN you pay taxes.
A Roth contribution is made with after-tax dollars, so there’s no deduction today, but when you withdraw funds in retirement, there is NO tax due.
Tax experts are encouraging more people to use Roths, even if they are in high current brackets or live in high tax states. The rationale is that tax rates are likely to rise in the future and even if they remain at these historic low levels, it is beneficial to have some retirement money that has already been taxed.
With traditional IRAs, you are entitled to a tax deduction today, but when you withdraw the money (as early as age 59½), the government will tax all of the funds as income, at whatever your tax bracket is at that time.
The government eventually forces you to take money out of traditional plans in the form of Required Minimum Distributions (RMDs). If you were born in 1950 or earlier, your RMD age is 72; for those born between 1951 and 1959, the age is 73; and if you are born in 1960 or later, your RMD age is 75. RMDs can often keep people in high tax brackets later in life and can also trigger extra costs for Medicare.
Fund a 529 plan
If you have children or grandchildren who are bound for college or private high school, funding a 529 plan is a tax efficient way to defray future costs. Your state of residence may offer a tax deduction for 529 plan contributions, so be sure to start with that plan.
Open/add to a brokerage account
Stocks have been on a massive run recently, but presuming that you don’t need the money within the next few years, investing in a diversified mix of low-cost index funds over the next years and decades makes sense for the long term.
As far as using a refund to pay down an outstanding mortgage balance, it depends on your situation and the rate of the loan.
When you pay down a mortgage, you lose access to the money – and as you age, that money could provide stability and also be necessary to fund health and medical needs.
Beyond liquidity issues, with a long enough time horizon, investing the money that you would use to pay down your home would likely result in higher returns than the rate of the mortgage.
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Jill Schlesinger, CFP, is a CBS News business analyst. A former options trader and CIO of an investment advisory firm, she welcomes comments and questions at askjill@jillonmoney.com. Check her website at www.jillonmoney.com.
