5 Ways to Maximize Your Tax Refund as a Young Professional
It’s often said there are only two things inevitable in life: death and taxes. However, for many young professionals tax time oftentimes comes with something slightly more exciting than taxes themselves and that’s the nice tax refund or seemingly free money that the government returns to you once your taxes have been filed. In fact, nearly 80% of Americans receive a tax refund, which is why it is so important to have a framework for how to best maximize tax refunds. In today’s blog we’ll outline five critical considerations for how to best utilize this money.
Top Off Your Emergency Savings
When it comes to financial priorities for young professionals—especially those with young families—there’s likely no more pressing financial priority than ensuring that you’ve built an adequate emergency savings account. The general rule of thumb—outlined recently by Lifewise in Time Magazine—is to ensure that you have at least three to six months of emergency savings in liquid cash. This money should be earmarked for emergencies only and should not serve as a slush fund that can be used to take spontaneous trips with friends and family.
This tax season if you find yourself with a juicy tax refund be sure to top of your emergency savings account, helping to insulate you from any potential problems that might come up (i.e. car needs new tires, hospital visit). If you work in sales or some other job that can see income fluctuate widely it usually makes sense to increase your cash buffer to six to 12 months, as the additional cash can help if your paychecks decide to take a break for a few months—an emergency!
Crush Your Debt
If you have an emergency savings account set up and fully funded, you should immediately look at any outstanding debts as an opportunity to maximize your tax refund by paying them down; especially the higher interest debts. If you have any outstanding credit card debt, you should utilize every last cent of your remaining tax refund to pay off that debt.
If you find yourself with no consumer debt, but instead maybe you have a low interest car loan, mortgage or maybe some student loans, give some thought to putting some of your tax refund toward paying down the principal on those loans—preferably the one with the higher interest rate, assuming all things are equal. When interest rates are as low as they are, especially on car loans, it isn’t always a bad thing to keep this debt, as long as you are investing the difference.
Further Reading: Your Credit Score – The Least Understood Aspect of Your Finances
Jumpstart Your Down Payment
It’s no secret many young professionals are considering the purchase of a new home at some point in the near future so what better way to jumpstart the process of saving for a new home than to save some of your tax refund money towards that down payment? In general, you’ll want to plan on paying for 20% of the home’s value up-front in the form of a down payment.
If you’re fortunate enough to get a tax refund of a couple thousand dollars this spring, putting a large chunk of that money into a short to intermediate-term savings vehicle with the goal of using that money for a house down payment can be hugely beneficial. Keep in mind if you are saving for a down payment on a house in the next few years, it is important to invest that money more conservatively than you might with retirement dollars, given that there is a shorter time horizon for the money.
Contribute to Your IRA
Hopefully you managed to contribute 10-20% of your income towards your retirement goals over the previous year, but if not, get a head start on your retirement contributions this year by taking a big chunk of your tax refund and throw it towards your long-term retirement goal.
In 2016, the IRS allows you to contribute $5,500 to a Traditional IRA or Roth IRA, which means if you get a generous refund from Uncle Sam you might be able to knock off a good portion of your IRA contribution for the year with your refund. Be careful when contributing to both a Traditional and Roth IRA as there are income phase-outs that limit your ability to deduct contributions to a traditional IRA and limit your ability to contribute to a Roth IRA.
Spend It on an Experience
If you’ve topped off your emergency savings account, paid off all high interest debt and thrown some of your remaining refund into a savings vehicle now comes the fun part. Here at Lifewise, we’re big proponents of utilizing money to live the perfect life and that means constantly balancing living for today while planning for tomorrow. If you’ve managed to better your future financial self by paying off debt and saving, then live it up a little bit with the remaining portion of your tax refund.
The amount you should consider using on your self today will vary widely by how much your refund was, how much you needed to contribute to emergency savings to top things off and how much debt may have been outstanding, but a good rule of thumb is to take 10-20% of your tax refund to spend on you. Yes, it is okay to have fun with some of the money Uncle Sam is paying back to you, as long as you tackle some of your other financial priorities first!
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