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Make your tax refund count

By Greg McBride, CFA · Bankrate.com
Wednesday, February 29, 2012
Posted: 5 pm ET

On Tuesday, I joined Oliver Pursche on the Money Matters Financial Network to talk about a key question on many Americans' minds these days: What should I do with my tax refund? Here's a condensed version of our conversation, in both written and spoken form.

Greg: There are some important steps you can take to shore up your personal finances and really make the most of it, and I'd say you start by paying down your high-cost debt. If you have credit card debt at 15 percent, that's a risk-free 15 percent return to take some of that refund and put it against that high-cost credit card debt.

Another one is: Pad your emergency savings account. Oliver, only 24 percent of American households – this is what Bankrate.com found last year – only 24 percent of American households have an adequate emergency savings cushion equal to at least six months' worth of expenses. Here's a great opportunity to take that windfall – that tax refund check – and really pad that emergency savings and put yourself on more solid footing as far as that rainy-day fund is concerned. Nothing is going to help you sleep better at night than knowing you have money tucked away for those unplanned expenses. And you can't count on credit to be your emergency fund.

What I tell people, particularly in this time of very low interest rates where people question the wisdom of having a bunch of cash tucked away in a savings account that will yield less than 1 percent, is: Don't look at this as what rate you're earning on that money. You're not putting money into savings accounts for the prospects of becoming fabulously wealthy anyway. The reason that you have that money there, and the way to think of it, is as your buffer between you and 15 percent credit card debt the next time an unplanned expense comes up. So don't look at it as, "Gee, I'm earning less than 1 percent on all this money," think of that as your buffer from other high-cost debt.

Oliver: I know you're also talking about funding your (individual retirement account), so I'll start with the most obvious question: Let's say somebody is very vigilant and files their tax return today. Technically, you have until April 15th (NOTE: actually April 17th, 2012) to make a 2011 IRA contribution. Could you make that IRA contribution with your tax refund if you indicated that you are making one or that you've made one? Сайт знакомств

Greg: Yes, you can do that, and I would absolutely agree about utilizing this window you have to make last year's IRA contribution because you're still going to have until April 15th of next year to make the 2012 contribution, so it's the one area of retirement savings where the door to 2011 has not yet slammed shut, and by all means, I think it makes sense to take advantage of that to whatever extent you possibly can.

Oliver: Yeah, and then lastly of course, and we touched on it a little bit in the beginning of our conversation: People need to realize that when you get a tax refund, you're really getting your own money back. It's not that the government is just, out of the good graces of its heart, sending you a check.

Greg: Yeah, this is your money, and as you said earlier, you've lent this interest free to Uncle Sam over the past year. There are two schools of thought to this. The conventional wisdom, and it's one that I think makes a lot of sense, is: Adjust your paycheck withholding so that rather than having to wait until this time next year to get that big refund check, you can get a little bit with each additional paycheck throughout the year.

People say, "Yeah, but if I do that, I'm just going to fritter it away. If I get that big tax refund in the spring, I know that's my opportunity to save." Adjust your paycheck withholding and then increase your 401(k) contribution accordingly so that it's automatically being saved and you're not giving Uncle Sam that interest-free loan throughout the year.

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