This time of year companies spend insane amounts of advertising dollars to convince us to buy that “big ticket” item with our large tax refund. Although it is nice any time we receive a check for several hundred or even thousands of dollars, we must remember why we received it. In the case of a federal tax refund, it is because we loaned the government of the United States a portion of our hard-earned money throughout the year at zero percent interest.
Re-evaluate your withholding for 2010
If you consistently receive large tax refunds, it may be more beneficial for your overall financial health to look at changing your payroll withholding.
This provides access to your income as weekly or monthly needs arise instead of in one lump sum each spring. If you keep your spending the same, this extra income each month can help you build emergency savings, pay down debts, or contribute to your nest egg.
There are several tools online to help, including a withholding calculator on IRS.gov. Once you figure out what you should do, you can change your withholding amount with your employer. Simply fill out a W-4 and change your withholding. Your employer should have additional copies of this form, or you can download it from IRS.gov.
Build up your emergency savings
Two weeks ago, we discussed ways to build your emergency savings to avoid using debt when situations arise that require quick access to cash. If you change to an appropriate level of withholding, this year’s refund will most likely be one of your last large ones.
Use this opportunity to initially fund or build your emergency savings. It is so tempting to rush out and buy that new 42-inch HDTV that you have had your eyes on. However, thinking long term will enable you to pay for items like this in a manner that keeps your overall financial situation healthy. You just may not be able to have it now.
Pay down debts
If you pay high interest payments to debtors, a wise use of your tax refund would be to pay off as much as you can. Then, the goal accomplished by changing your withholding is to have the cash flow to build your emergency savings and avoid additional debts that often build when urgent financial needs arise.
For example, let’s say you received a $3,600 tax refund this year. If you apply that to a debt that has a minimum monthly payment of $100 and also alter your withholding, you could free up an extra $400 per month in income. As long as you don’t take on additional debt, this added income gives you flexibility with your saving and spending.
Remember to revisit your situation each year. If your tax situation is complex or you are having a hard time figuring the proper amount of withholding, contact a tax professional.