Five smart ways to use your tax refund in a coronavirus economy
If you’re among the millions of Americans who are retired, nearing retirement, have been furloughed, laid-off or forced to live on a reduced paycheck right now, one small silver lining is that you may be eligible for a tax refund. The IRS has extended the deadline for submitting tax returns to July 15, but if you haven’t filed yours already, the sooner you can do so the better. Filing ahead of time means any refund you might be due will hopefully be processed quicker, too.
If you do get a refund, the first step is to properly assess your financial situation. In particular, make sure you have enough cash to cover essential items, like rent, mortgage, groceries and medication. But in uncertain times like these and with no one quite sure how long the economic aftereffects of the coronavirus will last, it’s important to think carefully about how any money you get back now can best serve you in the long term, too.
Here are five tips for how to use your tax refund to build a financial cushion for the future:
1. Build a rainy-day fund
Once you know your essential expenses are covered, try to park — or at least reduce — your spending on discretionary items, such as personal grooming, entertainment and clothing. As we all wait to see how and when something like normal life returns, it’s important to build a rainy-day fund you can draw upon in case of sudden job loss or a reduction in hours. Typically, this means having 3-6 months of living expenses saved up.
2. Pay down debt
The average annual percentage rate (APR) on credit cards tends to be between 15% and 20%. Store cards can be even higher. So, if you currently have large debts outstanding on a card or anywhere else with a substantial interest rate, think about using your tax refund to pay them off — be it partially or entirely. This will help limit any additional debt you accrue during the current crisis and can even help you develop good repayment habits for the future. Ideally, start by paying off the debt with the highest level of interest.
3. Consider a Roth IRA
If you’re a worker not in a high tax bracket and with enough cash to cover your day-to-day, consider investing your tax refund in a Roth IRA. This type of IRA is an individual retirement account and a great tool to build up a tax-free pot of money for the future. Your refund can go into the Roth as a 2020 contribution and then be invested in numerous ways, such as a brokerage account using mutual funds, index funds and more. The other good thing about Roth IRAs is they allow you to take back your principal investment without taxes or penalties. So, in the case of an emergency, you’ll still have some liquidity available.
4. Increase your payroll deductions to help reduce your tax liability
If you’re a W-2 employee with a 401(k) or 403(b) retirement plan, and are also in a higher tax bracket, increasing your payroll deduction can actually help reduce your overall tax liability. You can then use any subsequent refund from the IRS to supplement the reduction in your pay until it’s exhausted. Because employer plan contributions are typically deducted from payroll on a pretax basis, this is a smart option to get your refund into these plans while benefitting from a tax break as well.
5. Get professional advice
A financial professional and CPA can help you to determine the most sensible course of action for you and your family. In particular, they can help you navigate the options available, then select ones that best suit your financial circumstances, risk factors and investment goals. Crucially, an advisor can help you ensure you’re still able to quickly access enough funds should your position unexpectedly worsen.