When it comes to a windfall (say, the one an estimated 75% of taxpayers are getting this year courtesy of the IRS), our best intentions are often forgotten by the time the refund check arrives in the mail.
It may be hard to ignore the siren song of the electronics superstores with that refund burning a hole in your pocket (the average as of early March, according to the IRS, is $2,436), but try to show a little restraint. This is your shot at a bona fide money do-over -- the chance to right any financial wrongs you may have committed over the past year.
Here are a few ideas on how to blow that dough and feel good about yourself the next morning.
What to do with your tax refund check
Splurge (a little). Denial can be ugly, triggering a spending bender that will require a decade of tax refund checks to undo. So go ahead and treat yourself to a little something. Take a small portion of that tax paycheck (perhaps in the single-digit percentage range) and earmark it for a little indulgence.
Now that that's out of your system ...
Ruin your lender's day. Tackle any credit card debt. If you have more than one card, pick the account with the highest interest rate and pay it down. Or, if instant gratification's more your bag, concentrate on the card with the lowest balance. As long as you're picking off your debts, go ahead and negotiate a lower credit card interest rate so future payments will make a bigger impact. If your lender won't play ball, here's how to win the balance transfer game.
Reschedule your mortgage-burning bonfire
If you haven't already addressed the envelopes for your "No More Mortgage Payment" bash, consider moving up the date. Use your refund to send one extra mortgage payment to your lender this year. (Just make sure there's no pre-payment penalty and that you specify that the money be applied to the principal.) Then mark your calendar to do the same next year and the next and so on. Making one extra payment a year on a 30-year, 6.5% fixed-rate mortgage will shave more than $60,000 in interest and six years off the life of a $200,000 loan. Now start gathering kindling for that bonfire.
Brace for those "uh-oh" moments. It's always a good idea to have a stash of cash squirreled away for life's just-in-case occurrences. You want this emergency kitty there when you need it, so don't co-mingle it with your regular spending money. The interest rates you'll earn in a high-yield savings account (typically money market accounts) make parking your refund out of reach a little less painful. Most limit the number of monthly withdrawals you can make -- a good thing for those who succumb easily to temptation. Look for an account with minimum balance requirements that you can meet and which offers a rate that doesn't disappear after a teaser timeline.
Become the most popular person at cocktail parties. You don't have to buy a round of drinks to be the center of attention. A few good investment ideas will keep guests riveted and -- if you follow your own advice -- can set you up for a sweet retirement. Just tell guests how you're turning your $2,500 tax refund into more than $17,000. Here's the cheat sheet (be sure to commit the details to memory so you don't have to juggle note cards and your hors d'oeuvres): If you invest $2,500 -- last year's average refund amount -- and earn an 8% average annual return over 25 years, you end up with $17,121. It's as easy as 1-2-IRA. Shannon Zimmerman -- my Motley Fool Green Light co-advisor -- offers smart investing suggestions for stock market toe-dippers every month. (In the March issue of the newsletter, he offers two ETFs perfect for your IRA cash. You can read the article for no charge with a 30-day free trial.) In the meantime, see why high-yielding stocks like Lloyd's TSB Group (NYSE:LYG) might be good candidates for a Roth IRA. You can contribute as much as $4,000 (or up to $5,000 if you're age 50 or over) in your Roth or traditional IRA for 2007. Thank Uncle Sam for giving you a nice head start.
Get next year's tax refund right now
It's worth pointing out that a tax refund is not really a windfall at all. More accurately, it's money ($203 a month, to be exact) that you overpaid Uncle Sam all year. That's two c-notes a month that didn't earn you one dime of interest. At The Motley Fool, we call that the worst investment ever.
Most people have too much withheld from their paychecks for fear of underpaying the IRS and getting socked with a penalty. If you received a sizeable refund for 2006 and don't anticipate any major life changes (e.g., marriage, kids, gonzo inheritance) in 2007, then it makes sense to review your allowances on your W-4 and make adjustments. (Review again in June when you have half a year of withholding data for comparison.)
As for what to do with that paycheck padding? Well, scroll up and make your way through the list again for a few ideas.
Get a refund-like windfall every month
No need to drum your fingers until next year to see what kind of dough Uncle Sam will cough up. If you're like the average American (except, we know, with above-average intellect, wit, and style), there's a mountain of moola hidden in plain sight. Here are a few tips on unearthing some found money.
Lloyd's is an Inside Value recommendation.
Dayana Yochim cops to spending past tax refunds three times over by relying on faulty mental accounting and succumbing to shoe sales. This year is different. She swears. She vows to do right by her refund (after skimming just a few bills off the top for a trip to DSW) and follow up on a few of the compelling investment ideas served up by her Motley Fool Green Light co-Fool, Shannon Zimmerman.
