You open your mailbox and find a check for $3,317 from the U.S. Government. Are you dreaming? Maybe not, because according to the Internal Revenue Service, that’s the average tax refund this year.
So what will you do with this “free money” from the government?
Wake up and realize you gave Uncle Sam an interest-free loan for a year, financial planners say.
“If you’re getting an outsized tax refund, you may be withholding too much from your paycheck,” said Roger Oprandi, a certified financial planner with Vega & Oprandi Wealth Partners in Miami. “It is better to have that money in your pocket each month than to wait until the end of the year to ask Uncle Sam for it back.”
Go to www.IRS.gov and download Publication 15 (currently on the home page), which has tables in it to help you figure out how much to withhold from your check, said Alan Applebaum, a Cooper City certified public accountant and former IRS agent. Generally, the more exemptions you claim, the less is withheld from your check.
“Everybody’s tax situation is different, and you never know what next year is going to bring. So the first thing you should do is make sure your tax situation is going to be the same before you make any adjustments,” he said.
If you’re getting that big of a refund, go back and look at your W-4, Applebaum said.
“You should check your W-4 every year, regardless, to make sure it’s still accurate,” he said.
Still, about a third of Applebaum’s clients like getting a big refund to pay Christmas bills or credit card debt.
If they got the extra amount in their check each week, they would spend it and still go into debt, said Applebaum, who teaches accounting and taxes at Broward College. “So yes, it’s an interest-free loan, but it’s a forced way to save some money.”
Oprandi said that although some prefer to withhold too much so they will get that big check at the end of the year, they’re looking at it the wrong way. “The flaw in that thinking is if you have a tight budget in the household, you could use that money to either save systematically, or to pay bills to keep you from getting into debt,” he said.
If you do get an unexpected chunk of money this year, here is what financial planners advise:
Don’t blow it: Don’t squander it irresponsibly and spend it all on some luxury, said Austin Frye, a certified financial planner with Frye Financial Center in Aventura. “Don’t go to Vegas and bet on red. Don’t play the lottery,” he said. Stop and think.
“The biggest mistake people make is thinking that it’s ‘free money’ and now I get to go crazy with it,” Oprandi said.
Maintain balance: “If you get a windfall, use some part of it conservatively. Something you know is the right decision,” Frye said. “You’ll never look back and regret it. But take some calculated risks where you’re going to get some returns … If you do it in a balanced way, that’s a step toward successful financial planning.”
Pay down debt: If you do get a windfall, use two-thirds of it to pay down your highest-interest credit card, Oprandi said. The other third should go into a rainy day savings account so you don’t have to rely on credit card debt next time you’re in a pinch.
Start saving systematically: Instead of socking away your money with the government every month, set up your own plan, Oprandi said.
“Go to your bank or credit union and set up an account to put that money away,” he said. “In this case, we’re talking over $250 a month on average that you have that you could be putting in your own savings account, and accessing at some point.”
The challenge is that people are not used to saving systematically, and they’re not used to getting this kind of money, he said. “Having a structure in place — a savings account where this money can go into, is important. You need to have a destination to put money like this.”
If you need to pay for a car repair or if you get a tuition bill, you’ve got that money to rely on, he said.
Invest in your future: Help secure your retirement by opening a Roth or Traditional IRA. Give a loved one a hand with higher education through a 529 Plan.
“The 529 plan is one of the great gifts to the public from the IRS,” Frye said. “You can put money away for your own education, your children’s education, your grandchildren’s education, and the IRS is paying the freight. You’re getting free growth, and it’s never going to be taxed if it’s used for education.”
Start a rainy day savings fund: People don’t think they can afford to save, Oprandi said, “but it’s so important to build into your monthly budget and make it a priority.
“If you are single, you should have six months of expenses in a savings account. If you are a married couple where both are working, you can save three months. But it has to be completely liquid, not in the market, but money you can access at any time with no consequences.”
Invest in yourself: After you pay down debt and put away some emergency money, invest in yourself, Oprandi said. Donate to a charity you believe in (and get a tax-deduction for next year.) If you’re struggling with living a healthy lifestyle, hire a personal trainer. If you’re working on your golf game, hire an instructor. Or work on getting your finances in order by hiring a financial planner, Oprandi said.
“And it’s OK to have a little fun,” he said. “If you’ve always wanted to go on a cruise or go hiking in the Rockies, this may give you the opportunity to do that.”
Julie Landry Laviolette is founder of Story Bayou, Inc., www.storybayou.com, interactive storybook apps for kids 8-12.