Tax refunds a good way to get out of debt
It’s that time of year again; soon you will have many sources popping up suggesting ways to spend your upcoming tax refund. Let’s put this in perspective.
First, tax refunds are not “found” money, but a return of money YOU overpaid into the tax system! The average refund check is somewhere around $2,200 and $2,400.
One of the first things that you should do, if you had no abnormal deductions for the year and anticipate that those deductions will remain the same in the future, is to change your withholdings so you don’t overpay in 2006. I have no idea why you would want to give someone (even the government) money to hold onto for a year with no interest being made off of that money.
An easy way to calculate this adjustment is to take your refund amount, divide it by twelve and adjust your withholdings accordingly. Your company’s payroll department can assist you in this process. By doing this, it could give you several hundred dollars a month of additional money that you could use to get out of debt (pay off credit cards, auto loans, student loans, etc.) or assist you in your wealth building process.
Now that you have made your adjustments for the future, let’s get back to what you should do with that tax refund you will have coming in!
If you have credit card debt, PAY IT OFF! A $2,400 balance on a credit card at 17.9% interest with minimum payments being made, will take between 14 and 33 years to pay off. Now, let’s use debtors’ logic for a minute. You take the refund and spend it on something other than eliminating your debt or at least reducing it. Let’s say that you invest it telling yourself that you are going to start to add additional payments to your credit cards based upon the return you get from that $2,400 investment.
Fine, if you take the equivalent return needed, which is the after-tax return you would need to get if you invested the money in a traditional investment to generate enough money each month to make the minimum monthly payment on your credit card debt, it would be around 24% to 36%. If you find an investment opportunity with a guaranteed 24-36% after-tax return, please share it with all of us.
However, if you would take the money that get back from yourself (your overpayment of tax) and pay off that $2,400 credit card debt, then take the monthly payments that you had been wasting on your minimum payments and invested it each month during the same period (14 and 33 years), it would have grown to about $136,000 to $177,000.
Now obviously I know that the vast majority of us have more that $2,400 in credit card debt. We also have car payments, student loans, etc. Once you have made your adjustment on the amount of taxes withheld from your paycheck, use that “found” money to get out of debt first. Then you can invest, set up additional funds in your emergency reserves, etc.
If you do feel a bit overwhelmed by your debt and even your tax refund isn’t making a dent to make ends meet, seek some professional guidance. Be it either a credit counseling or debt elimination program, debt consolidation, whatever. There are always places and options you have available, but you must take the action to make it happen.
To learn more about your options and managing you debt, log onto www.debtreliefoptions.com.
Jon Noble
Staff writer
Debt Relief Options
asktheexperts@debtreliefoptions.com
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