Rebuild Household Finances Using Income Tax Refund Establish Reserve Fund, Or Pay Credit Card Debt

In the next few weeks, millions of American households will be faced with an enviable dilemma - what to do with their tax refunds.

About 80 million taxpayers, or two-thirds of those who filed federal income tax returns, will get nearly $100 billion in refunds this year. As of early April, 46 million checks totaling $61.5 billion were issued, each averaging $1,327.

What will most people do with this annual windfall?

“It’s amazing how many responses will come up,” said Rusty Wallower, tax research manager for H&R Block in Kansas City, which prepares 13 million returns in the United States.

Wallower says he’s heard them all - like the one from the horse aficionado who was using his to breed his mare or the unfortunate soul who had to pay off a loan shark. “He said he needed his refund right away,” he recalled.

A recent survey by the Minneapolis financial services company Lutheran Brotherhood found most responses on a more mundane level, though no clear consensus.

Thirty-seven percent would use their refunds to pay outstanding bills, 26 percent would invest or save, 14 percent would add it to their household budget and 9 percent would splurge. Another 14 percent hadn’t a clue.

Financial advisers say tax refund season represents a good time to help tie up some financial-planning loose ends.

Each household will have its own agenda.

The safest bet, most advisers say, is to treat the tax refund as a regular paycheck.

“You should do what you normally do with income,” said Marc Britton, director of personal financial planning for KPMG Peat Marwick in New York.

Topping the list of suggestions is lowering debt. “If you have credit card debt now is the time to pay it down,” Britton said. “You’ll save money in the long run.”

To be sure, if the interest rate on your credit card is 17.03 percent, the national average, and you have a $1,000 balance, you can save $170.30 by paying off the debt this year. If you pay off a $5,000 balance, the savings is $851.50. Now that’s a nice windfall.

Another option is to use the tax refund to start or add to an emergency cash reserve. Most advisers suggest setting aside between three and six months’ salary, but at least $5,000 should be sufficient for most households with relatively secure jobs and adequate insurance coverage.

If you haven’t already set up an investment portfolio, now would be an opportune time.

Despite the stock market’s recent volatility, most financial advisers still favor equities.

Good-performing mutual funds will provide even the smallest of investors with a diversified portfolio while offering reinvestment programs that automatically expand share holdings. Stick to stock funds with low sales commissions or none at all, known as no-loads.

Many of the more than 5,000 outstanding mutual funds have initial minimum investments of $1,000 or less; a few funds have no minimums. However, nearly all funds with minimums above $1,000 relax their requirements for Individual Retirement Accounts or if investors make regular contributions.

If the stock market makes you really nervous, a bank certificate of deposit or money-market mutual fund is a good way to keep your principal safe and earn inflation-beating interest in the meantime.

Larry Elkin, an accountant and financial planner in New York, says the worse thing anyone can do is become dependent on the tax refund for continuing normal expenses or for making ends meet. “You should treat it as a fluke source of income … so why not go out and take that splurge vacation,” he added.

There’s only one thing worse than depending on a refund, and that’s losing track of it. About 96,400 taxpayers have yet to receive $62 million in refunds from 1996. Most forgot to notify the IRS of an address change.