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How not to blow your tax refund

Gawker is running a fun article on How to Blow Your Tax Refund.  With the average refund expected to be approximately $3070, author Brian Maylan provides a number of ways to blow it all on a spontaneous set of expenses including a trip to Paris and one of each bit of hardware Apple has to offer.

We here at BYM have never really understood the “found money” mentality when it comes to tax refunds.  Perhaps that is because through a lifestyle of saving and spending wisely… every single item on Brian’s list can be planned and purchased easily with a little bit of thought.

For those new to living below your means, a tax refund is anything but “found money” or a gift or anything of the sort.  In fact, it is money that you overpaid to the government that is being returned to you — without interest.  It is money that would have been in your pocket each month had it not gone to the government’s coffers.

May people that plan their taxes well actually end up owing a little bit of money at tax time.  Assuming you are below the threshold for penalties and interest, this is a good thing.  It means that money was with you where it could be saved, invested, or otherwise used by you, and not a interest-free loan to Uncle Sam.

From the BYM point of view, here are the top 3 things to consider doing with your refund:

  • Pay off high interest debt – While it may not be as fun as a trip to Paris, consider this.  If you owe $10k on a credit card at 20% and only make the minimum payments of $200, it will take you 9 years to pay off the card and you will have paid $11680 in interest!If instead, you used that $3,000 towards the same credit card, and then made the same $200 a month payment, you would pay off the debt in 4 1/2 years and pay just $3593 in interest.  That’s $8,087 in savings over 9 years.  Enough to cover 2 or 3 trips to Paris.

 

  • Save it! – It may make sense to not use all of the money to pay down debt.  Having some money set aside in savings or an emergency fund is always good advice.  May experts recommend that you should be able to live off savings without any income for at least 3 months and ideally at least 6 months.  Having an emergency fund can actually save you money later and in some cases .  Perhaps put $1000 into a savings account and $2000 into the credit card.The reason for this is that access (liquidity) to money (capital) has value in and of itself.  Assuming you are not continuing to spend on the credit card, the terms of that loan are a known quantity.  If an emergency does arise and you need more money, access to credit may not be available, or it may be at terms that are worse than the terms you already have. For example, if you have a 5 year car loan at 0.9% – paying it off early doesn’t really make sense, especially if you don’t have an emergency fund.   This is because your money can be earning more interest in a CD or Money Market Account than you are paying on your auto loan.  Plus, if you do have an emergency, you’ll be paying anywhere from 13%-20% or higher on the credit card debt you’d take on to handle the emergency.

 

  • Put the money into a self-insurance fund – We here at BYM are not fans of being over insured.  Buying “warranties” on products because you can’t afford to replace them later is never a good idea.  Put the money into a savings account and use it only to pay for the replacement of items that are out of warranty.  In addition, consider raising the deductibles on your homeowners and auto insurance policies.  Do not raise the deductible more than the amount you are putting away, because if you have to borrow money to pay the deductible all the benefit is gone.Consider, raising a deductible from $250 to $1000 will reduce the cost of collision and comprehensive coverage by 10 to 30% depending on your carrier.  This can be as little as $100 or as much as a few hundred in savings per year.

If you just have to do something with that three grand, maybe allocate 10% to something fun.  $307 can buy you a very nice evening out – or two.

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