Monday, January 2, 2012

Tax Refunds

What to do before a Tax Refund
1. Don't count your chickens too soon:
You don't always get a refund, so you plan on the off chance that you could have some taxes due.  Make sure you have some liquid assets that could cover this scenario.
2. Organize your tax documents:
This will make doing your taxes less stressful and give you the records necessary for ensuring you get the most out of your refund.

What to do with a Tax Refund
1. Start or Increase Emergency Fund:
If you have an emergency fund, great! If not, this is a good chance to start one with the pile of cash you now have.  Good places to keep an emergency fund are savings bonds, online savings accounts, or some other form of investment with little to no principle risk.
2. Pay down Debt:
A small nagging debt or a high interest credit are wonderful monkeys to get off your back. Take this opportunity to get rid of it.  I would recommend you focus on something you can completely eliminate, unless you have something with an obscene interest rate.  The psychological win will put a smile on your face.
3. Roth IRA:
Probably the single best retirement vehicle available today.  It provides tax exempt retirement funds and principle that can be accessed in an emergency with no tax penalties.
4. Pay down your Mortgage:
If you are like me, you're paying your rent to the bank.  There is a light at the end of the tunnel; taking the refund and paying down principle on your mortgage will bring you a little closer to that light and will give you a guaranteed return at the rate of your mortgage.
5. Taxable Investment:
If you already have an emergency fund that makes you comfortable, acceptable fixed interest debt, and a fully funded retirement portfolio, you could start or increase your taxable investments.

What to do after the Tax Refund
1. Adjust your W-4:
Take the information from your most recent paycheck and go to IRS Withholding Calculator. Once you have your new numbers for your W-4, get it submitted and stop giving the IRS an interest free loan.
2. Plan your tax strategy for the next year:
If you have Passive Real Estate losses, make sure you are taking the necessary steps to not get phased out of these paper losses for next year, e.g. contributing to your 401(k) to reduce your MAGI to ensure you remain at your target Gross Taxable Income.