Some treat their tax return as a savings account. For them, that amount that’s withheld and then refunded is like a deferred deposit – the check just doesn’t clear until late winter or early spring, when we get those returns in the mail.
For high-income people, this isn’t the wisest strategy: they miss out on interest they’d accumulate by depositing right away. But for those who struggle to save because the budget is tight – often lower-income, younger folks – it may indeed make sense to withhold, because they don’t miss out on much interest – just on the chance to splurge throughout the year. A healthy tax return can be their saving grace.
Without further ado, then, we return to that question: what are we to do with that tax return? There are thousands of ways to use that check, but I’d like to delineate two very general categories first: paying off debt and saving.
- Pay off your debts. When you have extra cash sitting around, your first priority should always be to eliminate debt, because compound interest digs that hole deeper every month. Unlike your savings account, most of which look to grow, on average, at 0.5% this year, your credit card debt piles up at 15% – 30 times the rate! The answer is pretty clear: get rid of debt before it multiplies.
- Save once you’ve settled your debts. As we’d suggested earlier, there are thousands of ways to save, with so many accounts competing for your attention.
- There is, however, a first step that everyone should take. It’s not a specific type of savings account; it’s more of a savings strategy. It’s a safety net in case of a drop in income, and it’s called the Rainy Day Fund.
- Most financial advisors recommend it comprise 3 months to even a year’s worth of living expenses. That’s all your non-discretionary expenses, like rent or mortgage payments, insurance – everything you must pay lest you face severe penalties. The account you choose for this emergency fund can be one of many – skip to the next step to learn more on that front.
- Beyond the Rainy Day Fund, there are several other ways to save, and it all depends on your needs. If you have children, you might put it toward their college fund. If you’re a big shopper, you might want to save for the holidays next year. The list goes on.
- Pick the account for you. When do you open a savings account – or as you reevaluate your current account – you should know the general differences between them. Again, there are too many finer points for this article to name, but generally you should know that regular savings accounts will yield the least interest, money market accounts a bit more, and CDs even more than that, at least usually.
Before you run out to BrightStar, though, know that lower interest isn’t always a bad thing.
Why? Well, the rule of thumb in banking is this: the lower the interest, the greater the liquidity. In other words, you may not earn much on that regular savings account, but you have much freer access to your funds that you would on a 5-year certificate of deposit. Your choice depends on how much cash you already have to throw around, say in a checking account, and how much you’ll need.
Now that you’ve got the basics down, you’re ready to start weighing your options. There’s plenty of research you can do online, and, when you’re ready, stop by BrightStar to get rates and all the relevant details.
Michael D. Anderson writes for NerdWallet.com, a consumer finance comparison website.