For many Americans, tax season is as exciting as watching paint dry and as tedious as picking weeds in the garden. The best or worst moment is finalizing the calculations that determine whether you get a refund or a tax bill. Here are some tips on how you can use either outcome to improve your future financial wellness:
The Happy And Exciting Feeling Of Getting A Tax Refund
Before you start planning that well-deserved trip or buying that big-ticket item, consider having your money make some financial priority pit stops that could be more beneficial for you in the long run.
Prioritize emergency savings
An emergency fund is a major part of financial resilience in the event of an unexpectedly large expense or losing income for an extended period of time. I encourage most individuals to have at least $2,000 to $3,000 as a starting point and then build toward three to six months of necessary expenses by implementing an automated savings plan.
Consider opening a separate savings account and setting aside some or all of your refund toward an emergency fund. You can check out options at a website like depositaccounts.com.
Prioritize paying off debt
If you have debt with an interest rate that is higher than 7%, you may want to prioritize paying that off to save you interest, time and stress. For example, putting a $2,000 refund as a one-time payment toward a $5,000 debt at 19% interest would save you about $4,000 in interest and cut the payoff period from 8 years to about 3.5 years if you are only making a $100 payment and don’t incur any more debt.
Putting a $2k refund towards that debt every year would pay it all off in about one year and save you a total of about $5,000 in interest. You can use the DebtBlaster calculator to see how much interest you can save by using your refund to pay off debt.
Invest
Do you have any other goals that matter to you over the next five years, 10 years and beyond? How can this refund help jump-start saving for goals like a down payment for a new car or home or retirement? Depending on your goal, check out what a lump sum saved and invested over a period of time can yield you in the future using a calculator like this one. Here are some additional tips on how to invest based on your goals.
Plan for the future and update your Form W-4
If you regularly receive a large tax refund, you’re essentially lending the IRS money for free. Instead, adjust your withholding so that you ideally owe little to nothing. By doing this, you can receive your “refund” in the form of additional monthly cash flow that you can immediately put toward your financial goals. I also encourage you to take the extra step of using this tax withholding estimator.
The Dreadful Feeling Of A Large Tax Bill
Getting a large tax bill is never fun, and it can often be an unexpected expense at the worst possible time. Here are a few strategies to help you deal with this kind of financial burden and plan for the future.
Pay the bill in full by the tax filing deadline (even if you file for an extension)
If for some reason you can’t afford to pay your bill by the deadline, you can still lower late filing penalties and interest fees by paying as much of it as possible.
Request a payment extension
If you are going through a financial hardship, the IRS could offer you a 6-month grace period/payment extension. You will have to demonstrate a substantial financial loss.
Set up a payment plan
If you are unable to pay your bill in full and don’t qualify for a payment extension, you can establish a payment plan with the IRS. There will be a small fee to set this up in addition to interest. However, a payment plan keeps you in the IRS’ good graces as long as you stick to it, and it helps you avoid additional penalties related to missed deadlines.
Plan for the future and update your W-4
If you’re unable to afford the lower paycheck from the increased withholding, then it’s time to revisit your spending to ensure you are living within your means. You can use this resource to help you in those efforts.
Whatever your outcome is from tax season, I hope these tips help you realize how to use your bill or refund as an opportunity to improve your financial situation and set yourself up for a better financial future. Consider consulting with a qualified and unbiased financial professional as well. Ask your employer if you have access to one for free through a workplace financial wellness program.
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