Put that nice big tax refund to good use


April 07, 2002|By Eileen Ambrose

THANKS TO tax law changes last year, many taxpayers will be getting a bigger refund now.

As of last week, the average refund was $1,964, up 12 percent from a year ago.

Some may take the refund as an opportunity to splurge on a vacation or a trip to the mall. While that may be good for the economy, it's not for their own finances.

"Let other people bail out the economy," said Don Blandin, president of the American Savings Education Council in Washington.

Instead, Blandin and other financial experts suggest using a refund to reap some longer-lasting financial benefits. Here are their suggestions for those receiving the average refund this year:

Create or replenish an emergency fund, which is generally three to six months' worth of living expenses. With an emergency fund, you won't have to rack up credit-card debt or tap into retirement savings to pay for unexpected expenses.

Pay down credit cards, especially plastic with interest rates of more than 10 percent

"In doing so, you essentially get a guaranteed return on your money for that percentage rate," said Jonathan Murray, a senior vice president of investments for Legg Mason Wood Walker in Baltimore. "If Visa is charging you 18 percent interest, there is no investment alive that can give you a guaranteed rate of return of 18 percent."

Invest. If you're rebalancing your portfolio, you might find you are a little low on stocks because of the weak market. "It might be a good time to put that money to work in the stock market ... maybe with a wiser attitude," Sue Stevens, director of financial planning for Morningstar Inc., said.

Instead of chasing the hot mutual fund, pick a steady performer, such as a large cap value stock fund, she said.

Murray suggests mutual funds that invest in small- and mid-cap stocks, which have outperformed large-cap stocks the last three times the economy emerged from a recession.

Make a contribution to an individual retirement account. The maximum contribution has been raised from $2,000 to $3,000 this year for workers under age 50, and to $3,500 for those 50 and older.

Use the refund to salt more away into your 401(k) this year - without experiencing a drop in spending money.

Here's how: First, put the refund in a money-market account. Then ratchet up contributions to the 401(k) by $250 a month, or $3,000 a year, said Rick McCallister, a financial planner in Torrance, Calif. (This example is based on a single worker making $72,000 a year.)

Because making 401(k) contributions reduces your taxable income, putting in an extra $250 will cut your take-home pay by only $163 a month, McCallister said. But you won't feel the pinch if you withdraw $163 each month from your money-market account and put it in your checking account.

Save for a child's college education. The new tax law has made some options more attractive.

For example, the Coverdell Education Savings Account, which used to be called an Education IRA, has undergone more than a name change.

Beginning this year, the maximum annual contribution is $2,000, up from $500.

Earnings in this account are still not federally taxed if used for qualified education expenses, but the money now can be used for more than just college costs. You can use the cash for a wide range of kindergarten through high school expenses.

Eligibility and contributions depend on income. Singles with adjusted gross income of $110,000 or more cannot contribute. For married couples, the cutoff is $220,000.

Or, consider a college savings plan, which most states now offer. Money is invested on behalf of contributors. There are no income limits to participation. You can save a bundle, too, with some states letting you contribute until account balances for the child reach $235,000 or more.

The money can be withdrawn tax-free for qualified college expenses. Some states, including Maryland, also give tax deductions to residents investing in their state plan.

Invest in yourself, advised Frank Gleberman, a financial planner in Marina Del Rey, Calif.

For example, a midlevel manager could hire a speech coach to develop speaking skills or public relations specialists and real estate agents can buy better computer equipment to improve their presentations to clients, Gleberman said.

The financial return could be a promotion, raise or increased business, Gleberman said. Or, the payoff may come in raising your quality of life, he said.

If you expect to remain in your home a long time, tell your lender to use the money from the refund to pay down your mortgage principal, said Steven J. Williams, a financial planner in Santa Monica, Calif. That way you'll owe less interest and pay off the loan sooner, he said.

For example, applying a $2,000 refund to reducing principal on a $300,000 mortgage could lop off almost a year on the life of a 30-year mortgage, he said.

To suggest a column idea, contact Eileen Ambrose at 410-332-6984 or by e-mail at eileen.ambrose@baltsun.com.

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