USE TAX REFUNDS TO PAY DOWN DEBT
Rebekah Coleman | Tuesday, February 12, 2013
After the consuming task of submitting tax returns, the beneficial part arrives: payday.
Instead of spending the return in a frivolous manner, taxpayers should utilize this annual check from the government to reduce their debts, including personal loans and credit cards.
According to a recent TD Ameritrade survey , nearly half of Americans expect an income tax refund this year. Of those consumers that expect a tax refund, almost half plan to reduce their debts. Forty-three percent, to be more precise, plan to pay off debts with their refund.
Christina Goethe, spokeswoman for TD Ameritrade, said this year’s findings are similar to last year’s survey.
“From our perspective, the fact that people are going to save and pay off debt is pretty important,” she said to loans.org.
Lule Demmissie, managing director of investment products and retirement at TD Ameritrade, agreed with Goethe.
“It’s good to see that people are more likely to save their tax refund or use it to pay down debt rather than perhaps spending it unwisely,” Demmissie said in a statement.
The survey reviewed taxpayer’s spending habits based on their marital status. For men and women, the findings varied based on their current status. Single men are more likely to save their income tax return than women. However in married couples, married women out-save their male counterparts.
Goethe said that last year’s survey did not analyze this aspect, but overall TD Ameritrade surveys from the past five years show consistent results.
She said that although it is speculative, women could plan less for their finances when single because traditional gender roles are still there in society. She said women are taught less about money roles. But when they have a family, women start to focus on long-term financial goals.
“Those roles are definitely shifting,” she said. “We know that many women are the CFO of the household.”
Goethe said once women are married, they are more likely to take on the money management roles of the household, especially now that more and more women are become the primary breadwinners in the family.
“Women … have a huge handle on the finances of the family,” she said.
The survey also reviewed income return spending habits based on generations. The survey found that Generation Y (born from the early 1980s to the early 2000s) plans to save their income tax refund more than Generation X (born from early 1960s to early 1980s) and Baby Boomers (born between 1946 and 1964). About 58 percent of Generation Y plans to save their refund compared with 36 percent of Generation X and 40 percent of Baby Boomers.
Goethe said this occurs due to a mix of both financial status and a willingness to learn. She said it is easier for Generation Y to save the refund because they do not have the expenses that Generation X and Baby Boomers have.
Another reason is because of the lessons they learned from their parents. Generation Y grew up in the recession and they were able to see the importance of saving for the unexpected. Goethe said this generation’s prevalence to save their refund is because they are mimicking the mature generation’s behaviors of saving.
How to Tackle Debts
Unless previously budgeted for, tax returns act as free money for consumers. While it is entertaining for some to spend the money on consumer goods, using the money to improve one’s financial livelihood is likely to benefit the consumer for a longer period of time.
Paying off debts of any kind is beneficial, but some debts can impact the consumer more, if they are eliminated. High interest consumer debts such as personal loans and credit cards stand to benefit the most from tax returns.
These high interest debts should be paid off first. Goethe said paying down debts in one lump sum can help. Payday loans and personal loans should be repaid quickly since these are structured for short-term lending and tend to cost consumers more interest on the long-term.
Larger debts such as mortgages and auto loans are nearly impossible to pay off in a singular transaction, but if personal debts are small, taxpayers can use their tax returns and eliminate an entire monthly bill.
Eliminating a personal loan debt will also reduce the overall interest paid to the lender. Depending on the interest rate, paying off a $3,000 personal loan could save a borrower hundreds of dollars in interest during the year.
Review Withholdings Carefully
In order to utilize tax returns, sometimes it is best to receive less during tax season, and more throughout the year. Large tax returns are a sign that the government kept a portion of a consumer’s income all year long.
Katie Ross, education and development manager at American Consumer Credit Counseling (ACCC) said large tax returns are a sign that the government kept a portion of a consumer’s income all year long and acquired an interest free loan.
“Most people think their tax refund is a nice little wind fall that the government is just handing out when in actuality this is your hard earned money that you have given to the government as a loan with no interest earned,” Ross said.
When taxpayers receive large tax returns each year, they should review the withholdings on their W-2 forms. If they alter their withholdings, they might be able to receive more money each paycheck, and less in one lump sum.
But some consumers rely on this large payment. Some taxpayers know the income return is coming each year, so they plan it into their budget.
Goethe wonders if that is a logical plan.
“Are you planning on having the government act as your savings account,” she questioned.
Instead, consumers should then ask themselves how they can utilize that money throughout the year.
“While a tax refund … could pay for a nice long weekend away or a Caribbean vacation, you should use your tax refund wisely to keep yourself out of harm’s way of going into further debt,” Ross said.
Additional money each paycheck could assist in paying for monthly bills or it could be automatically added to a retirement or savings plan. Goethe said automatic savings accounts are important. She said if money never touches a person’s hands, it is easier to spend wisely.
Planning ahead is one of the most important aspects during tax season. It is easy to spend an entire tax refund if a plan of action is not set in place. Making a set plan ensures that the entire income tax refund is spent exactly as the taxpayer wants whether that is for repaying personal loan debts, adding to a savings fund or buying consumer goods.