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Why You Should Apply the 72-hour Rule to Your Tax Refund

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Why You Should Apply the 72-hour Rule to Your Tax Refund

Ka-ching! Your tax refund just hit your checking account. Time to apply the 72-hour rule.

Whether your refund is in the thousands or hundreds, the urge to spend the funds might instantly become overwhelming. Maybe you already had an idea of what you want to spend the money on and you’re all set to hand over your refund for it. Or, maybe the money means you finally have enough to make a large purchase you’d otherwise need to save for.

Whatever your reason, don’t spend your refund quite yet. If it’s not an immediate emergency (read: root canal, car accident, flood, etc.), let the cash burn a hole in your pocket for about 72 hours.

Journalist and money expert Carl Richards came up with the “72-hour rule” to kick his habit of buying every book he wanted on Amazon, ending up with a pile of unread books. Now, he says he lets a book sit in his shopping cart for at least 72 hours before hitting “buy,” and he’s saving money only buying books he will actually read. You can apply a similar practice to your spending habits.

Why wait 72 hours?

Our brains respond positively to instant gratification. It’s why so many of us find it difficult to save money or lose weight. We want the item or food now, and when there’s nothing stopping us, why wait?

You need the space between receiving the money and spending it to think. The shorter that space is, the less time you have to think and the more likely you are to spend the funds impulsively.

“People often look at their tax refund as found money like lottery winnings or inheritance. The temptation to spend surprise money on something fun or frivolous is strong,” says Denver, Colo.-based Certified Financial Planner Kristi Sullivan.

You want to avoid doing that. Your tax refund isn’t lottery winnings or an inheritance. It’s your hard-earned money being returned to you with no interest gained.

Tax refunds averaged $2,860 in 2016, according to the IRS. This year, a SunTrust survey found about 1 in 4 Americans already planned to spend their refund money on a large purchase before they even received the funds. That proportion rises to 36% among millennials and 40% among Gen-Xers, according to SunTrust.

That’s no bueno, considering the average citizen admits they can’t pull together $400 in case of an emergency.

James Kinney, a certified financial planner based in Bridgewater Township, N.J., says “hitting the pause button on spending impulses gives the rational brain time to think” of more practical ways to use the money like getting out of debt, contributing to a college savings fund, or adding to your savings.

Although he acknowledges when you’re living paycheck to paycheck, it’s a little harder to resist a sudden — albeit predictable — boost to this month’s budget.

“People feel constrained by their paycheck all through the year, then suddenly this windfall of money gives them the ability to splurge. The temptation can be hard to resist,” says Kinney.

Here are a few ways you can manage the temptation, and the time.

While you wait…

Weigh your wants vs. needs

The waiting period is supposed to help you to spend your tax refund responsibly, right? Consider all of the expenses the money could go toward. Should you buy the new iPad or pay off your credit card? How about that car loan? Time to weigh your options.

Sullivan says that means you should pit your “wants” against your “needs.”

“A need that you haven’t already bought is rare. Wants are everywhere. Time to reflect might have you making a more mature decision with your money,” says Sullivan.

Do some soul searching to see where your financial priorities lie. You might find your need to pay off your credit card this month to avoid paying more in interest outweighs how badly you want that new gadget. Think about it.

Review your finances

Since your tax refund might consume your every thought for three days, you might as well use the time to think about your overall financial picture.

“Sit down and think about other pressing financial issues, and how you plan on paying for them,” says David Frisch, a Melville, N.Y.-based financial planner. He suggests you review bank statements, brokerage accounts, long-term goals, and other financial considerations, then give some thought to whether or not you’re on track to achieve them.

For example, if you realize you don’t have enough in your emergency fund to cover three to six months of expenses, you might decide to put the money there instead of spending it. Or, if your refund could completely pay off a high-interest debt like a credit card, you might decide to free yourself from the debt burden.

Make sure you don’t get a huge refund every year

Most Americans receive a refund because the government withheld too much in taxes. The government uses information you gave them to decide how much of your paycheck to withhold each pay period.

“Changing your withholding will give you more of your money during the year so that you will not get a large refund that you might be tempted to spend frivolously,” says Alfred Giovetti, president of the National Society of Accountants.

You can change information on your withholding forms on your own if you’d like. Use this IRS calculator to determine your proper withholding and figure out what information you need to correct on your W-4 form. Then, contact your employer’s human resources department to turn in a new W-4 with the correct information.

If you’d rather have some assistance, you can contact a professional. Work with your accountant or financial adviser to change information on your W-4 and its equivalent withholding form for the state in which you reside.

“Plan with a good tax accountant to get a small refund or a small liability by changing your withholding, so that you do not rely on the refund as ‘mad money,’” says Giovetti.

Treat yourself

We admit, waiting sucks, but it doesn’t have to be complete torture. Sullivan suggests taking the edge off with a small reward for each day you wait.

“It could be an ice cream cone, a long phone chat with a friend, an hour reading a trashy novel, or whatever makes you happy,” she says.

Just make sure the reward you choose isn’t too expensive, and you should avoid getting into more debt. Your “reward” could serve as a break while you comb through your finances.

The takeaway

Take some time to think before spending whenever you receive unexpected income, and you might make better spending decisions. Maybe you need only 24 hours, instead of 72, or maybe you need a little longer to decide what to do with money, but the same lesson applies. If you’re considering a purchase that’s a “want” and not a “need,” think before you buy.

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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Pay Down My Debt

How to Use Your Tax Refund to Get Out of Debt

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

piggybank

Some individuals, including myself, are not thrilled about filing their income taxes each year because they typically end up owing the government. However for millions of Americans, the result of income tax filing will be in their favor.

The IRS reported on February 26 that for the current tax-filing season, the average refund is $3,120 and it had already issued over $125 billion in tax refunds.

Side-stepping the common argument that a tax refund is essentially money that you inadvertently loaned to the government, the more important concern is how best to utilize this surplus of cash.

While splurging on a new spring wardrobe or taking an all-inclusive vacation sounds fun, if you have debt, especially consumer debt, then it’s a good idea to put the brakes on the carefree spending options.

Instead, invest in your financial health and pay down debt by using your tax refund in the following ways.

Crush Your Credit Card Balance

You likely know how much you owe, but do you know how much interest you’re being charged?

If you don’t know your credit card’s interest rate, then take a look at your most recent statement. The average interest rate is near 15% and it’s even higher for retailer credit cards such as Macy’s or Home Depot. By paying off high interest debt like credit cards, you are getting an immediate return on savings of the interest expense.

It’s frustrating to pay off a $5K credit card balance when making only the monthly minimum payments but if you were to reduce the balance with a $2500 refund in one fell swoop, you will have shaved over a year off your debt repayment schedule.

Even better, you could utilize a balance transfer to drop your interest rate to 0% and then your entire refund could go towards paying off the principal debt. You could dig out of debt months or years faster and save hundreds to thousands of dollars.

promo-balancetransfer-wide

Get a Head Start on Your Student Loans

You may not have any credit card debt but you do have student loans piling up alongside with your stress levels.

Although student loan interest rates are not nearly as high as those of credit cards, the current rate for the 2014-2015 school year for the undergraduate Stafford loan is 4.66%.

At the latter rate, it would cost you $1,264.55 in interest for a $5,000 loan over a ten year repayment period. Apply your mathematical sense to lessen the amount of interest and pay your student loan sooner thanks to a lump sum payment like a tax refund.

Deal With Debt in Collections

Whether it’s due to poor financial decisions or a life crisis such as a job loss or medical event, you may have a past due account that has been sold by the creditor to a collections agency.

If you can truly not afford to repay the debt in full, try negotiating a settlement amount with the collections’ company that can be covered in part or whole with the proceeds of your refund.

[7 Things You Need to Know If You Have Debt in Collections]

Once you have a signed agreement in place, you will have avoided the possibility of a lawsuit and begun the process of repairing your credit history, even though the settlement could appear on your credit report for seven years. Also note that the unpaid amount not included in the settlement will be reported to the IRS and federal income tax may be owed as a result.

Honor Personal Debts

I didn’t like owing creditors when I was working to pay off my consumer debt but owing a parent or friend money would be a debt I’d want to pay off as fast as humanly possible.

These types of personal loans typically tend to attach little to no interest rates but they can be fraught with emotional strings. Circumstances can change wherein the lender, aka the bank of Mom & Dad, were initially in the position to lend you the cash but are now in need of the funds. This may cause a strain on the relationship if the debt remains unpaid.

Being able to pay down a personal loan in part or in full with your tax refund can provide a source of fiscal and psychological relief not only for yourself but for the person you care for that funded the loan.

Save a Little

A tax refund can also be used to pay down debt and create an emergency savings fund. Emergency funds can prevent you from sinking deeper into debt in the future when something goes wrong with the car or an unexpected medical expense pops up. Putting $500 or $1,000 away in a savings account provides a helpful debt buffer.

Using your tax refund to pay down debt may not elicit the same level of excitement as treating yourself to some wants, yet you are wisely positioning yourself to reap financial benefits in the short and long term.

Kassandra Dasent |

Kassandra Dasent is a writer at MagnifyMoney. You can email Kassandra at kassandra@magnifymoney.com

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Choose Your Own Adventure to Maximize Your Tax Refund

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Tax return check

Tax return season is here. You have over a month left to file (don’t miss that April 18th deadline!). With an average refund of $3,120 in 2015, it’s easy to start daydreaming of beach vacations, ditching your clunker car, finally putting that pool in the backyard or upgrading your wardrobe. Before you stumble down the rabbit hole of what your tax return could buy, consider how the money you’re getting back from Uncle Sam could resolve existing financial issues.

Below, we’ve laid out common scenarios and how best to handle them. You can read the entire article or pick your own adventure by clicking to your situation.

You’re Paying Down Credit Card Debt and Have a 700+ Credit Score

Credit card debt is painful. It usually comes with interest rates north of 15% and can take years to pay down because so much of your monthly payment is going to interest alone. When you suddenly come into hundreds or thousands of dollars, it’s an opportunity to make a big dent in your credit card debt.

promo-balancetransfer-halfBefore you haphazardly throw a lump sum at your credit card debt, you should think through the best repayment strategy.

Make a list of all your credit card debt and the associated APRs. You want to attack the debt with highest APR first. This is when a good credit score comes in handy. High credit scores usually mean you qualify for balance transfer offers.

With a balance transfer you can move your debt from a high interest rate to 0%. Then you can put your lump sum payment towards just the principal balance and knock out your debt not only faster and with less interest paid! Even with paying a fee to complete the balance transfer, this strategy could save you thousands of dollars.

[See how much the APR on your credit card is really costing you.]

Top Balance Transfer Offers

Find the best balance transfer for you here.

You’re Paying Down Consumer Debt and Have a 660+ Credit Score

Not everyone is eligible for balance transfers, but personal loans often offer opportunities to reduce interest rates, even if your credit score is below 700. You could potentially consolidate all your credit card debt or other debt into one loan with a lower interest rate.

Keep in mind, the lower your credit score the higher your interest rate.

You can fill out an application for the personal loan providers below and each one will do a soft pull of your credit report to offer you an interest rate. A soft pull means your credit score won’t be harmed. Once you take the loan, your credit score will take a bit of a hit because you’ve established a new line of credit.

It’s important for you to know your interest rate ahead of time to make sure it makes financial sense to take out the personal loan. If your credit cards are at 18% but you only can get a personal loan at 20%, it probably doesn’t make sense to make the switch. Instead, work on improving your credit score and then applying for a balance transfer.

Top Personal Loan Offers

SoFi*

  • Maximum Loan: $100,000
  • Minimum Credit Score: No minimum required
  • Duration: 84 months
  • APR: 5.49% – 14.24% (fixed APR with enrollment in autopay)
  • College education required
  • Soft pull of your credit report to see if you’re approved
  • No origination fee and no pre-payment penalty

Earnest*

  • Maximum Loan: $50,000
  • Minimum Credit Score: 720
  • Duration: 36 months
  • APR: 5.25% – 14.24%
  • College education required
  • Soft pull of your credit report to see if you’re approved
  • No origination fee and no pre-payment penalty

Lending Club*

  • Maximum Loan: $40,000
  • Minimum Credit Score: 600
  • Duration: up to 60 months
  • APR: 5.99% – 35.89% APR
  • Soft pull of your credit report to see if you’re approved
  • There is an origination fee

Find other personal loan options here.

Your Credit Score Needs Improvement

Dealing with a credit score in the low 600s or below? Focus on improving your score. It won’t happen overnight, but you can start to rebuild by:

  • Paying your credit card bills on time (at least the minimum but preferably more)
  • Dropping your utilization to 20% or less (spend less than 20% of your total available credit on credit cards)
  • Be pumping in good information by responsibly using existing credit
  • Consider getting a secured card to establish or rebuild your credit history
  • Determine how best to handle items with collections agencies
  • Applying for a store card may help: it sounds counter-intuitive, but if you have a score high enough to get a store credit card (usually in the mid-600s) this will increase your available credit which automatically reduces your utilization if you don’t up your spending. Just lock the credit card away and unsubscribe to tempting emails about sales and deals.

[Explore our Building Credit section for additional tips.]

You’re Dealing with Student Loan Debt

Student loans come with a tax deduction. While no one likes owing money, at least Uncle Sam gives the indebted a little bit of a break at tax time. The student loan interest deduction is for those carrying student loans with a modified adjusted gross income of less than $80,000 (filing separately) or $160,000 (filing jointly). You can reduce your taxable income by up to $2,500.

So, if you took advantage of this tax deduction to increase your tax return, put it to good use.

The best strategy is to apply your refund in a lump sum towards your debt with the highest interest rate. However, if you have a private student loan, you may want to knock that one out first. Private student loans don’t receive the same benefits as Federal student loans, including: forgiveness programs and many don’t have forbearance options if you’re unable to pay.

You could also refinance your student loans to a lower interest rate and then put the lump sum payment towards the loans. Thanks to the lower interest rate, you’ll chip away at your principal balance even faster. Learn more about refinancing here.

Make sure you tell your lender the lump sum should be going towards your principal balance not your monthly payment. If you pay ahead it may show as $0 due on your next statement. Don’t let this confuse you into not paying. Keep paying at least your monthly amount to get ahead of interest owed.

Good to Know: The Federal Government can seize your tax return and put it towards your student loans if you’re in default. You should also double check if there is a pre-payment penalty on any of your student loans meaning if you pay them off early you’ll be charged a set amount.

You Have Less than $1,000 in an Emergency Fund

It can be tempting to put all your extra money towards paying off debt. Don’t. You need to have a buffer in an emergency fund savings account. This money should be held separately from your checking account so you aren’t tempted to spend it on daily purchases or debt repayment.

Putting $1,000 away in savings can keep you from digging deeper into debt when the unexpected happens. Think Murphy’s Law: What can go wrong, will go wrong. Without a savings buffer a home repair will pop up, a car part will malfunction, a medical emergency will arise and you’ll end up putting the charge on a credit card or overdrawing an account.

Once you’re debt free, you should try to have at least six months worth of income saved up in case of a job loss or unforeseen event that could leave you scrambling for cash.

Your savings should be housed in an account earning more than 0.01% (the average from the big banks).

Savings Account with High Interest Rates

It is possible to earn well above 1.00% APY with an online savings account. You can find the best online savings accounts, updated regularly, here.

You Have Extra Money After Paying Off Debt and Saving for Emergencies

Perhaps you’re one of the fortunate individuals to knock out debt this year and fully fund an emergency savings account. What financial priorities should be handled next?

Retirement

Using this year’s tax return to get a tax break for next year is always a smart play. Dump your return into a Traditional IRA to lower your taxable income in 2015. If you don’t need the tax break now and prefer to take it in retirement, put your money into a Roth IRA. Be sure you aren’t over contributing to your retirement plan. Check in with the IRS guidelines before putting your money into an IRA.

College Savings

Got kids? Put your tax refund away for their futures. You can save in a 529 Plan, which affords the opportunity to grow money tax free and make eligible withdrawals tax free at the federal level and often state too. The money has to be used for higher education expenses or you’ll face penalties.

Live a Little

You’re debt free, ready for emergencies and eyeing that tax return hungrily. It’s okay to splurge. If you can afford to make a purchase you’ve been considering and it won’t send you reeling into debt or sucked into a hole of overspending, it’s okay. Money shouldn’t always be hoarded away.

Get Help By Downloading Our FREE Guide to Ditching Debt Forever!

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Erin Lowry
Erin Lowry |

Erin Lowry is a writer at MagnifyMoney. You can email Erin at erin@magnifymoney.com

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