Attorney John Mlnarik
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How to Use a Tax Return after Consolidating Student Loans
When a person files taxes in which he or she has paid a greater amount of taxes than his or her tax liability requires, he or she can receive a tax return. In some situations, a person may have taken the steps to consolidate student loans and may look for other ways to save. Some possible ways to smartly use these funds include:
Pay Off Student Loans
Consolidating student loans does not mean that the loans are gone. They have simply been combined together to offer one payment and one interest rate. Student loans are often not dischargeable in bankruptcy. Additionally, consolidating student loans may eliminate payment alternatives such as a deferment or forbearance, so if you get into financial trouble, you may have fewer options when paying your student loans. You can take the extra funds from your tax return to completely pay off a portion of your student loans.
Pay Off Credit Card Debt
The interest rate on many credit cards that have accumulated debt are usually greater than the comparative interest rate that an investment will yield. Therefore, if a person owes credit card debt, especially with a high interest rate, it makes sense to pay off this high-cost debt.
Establish an Emergency Fund
Many times a person gets into debt because he or she does not have savings on hand to handle an emergency like vehicle repairs, a house fire, theft, medical emergency or other catastrophe. With many tax returns representing thousands of dollars, using it to establish an emergency fund can help individuals get an important start to this fund. Financial advisors often recommend that people have an emergency fund equal to six months’ of expenses. For example, if a person’s monthly expenses are $2,000, the emergency fund should be at least $12,000.
Invest in a Roth IRA
Individuals can contribute $5,500 to a Roth Individual Retirement Account in 2016 and withdraw the funds tax-free in retirement. The full amount can be contributed as long as your income is less than $117,000 if you are single or $184,000 if you are filing a joint tax return. The amount that you can contribute decreases incrementally from $117,000 to $133,000 and $184,000 to $193,000 for single and married filers jointly.
Invest in Other Retirement Accounts
You may have other retirement account investments that you can make with the extra funds. With 401(k)s with employer matches, you are basically doubling contributions that you make up to a certain dollar or percentage amount. You may also want to look into setting up a traditional IRA, invest in stocks or invest in bonds. Talk to a financial planner to learn about the various options, risks and advantages.
Pay Off Debt
Evaluate other sources of debt that you have including mortgages, private loans, lines of credit, home equity loans, automotive loans and other debt. Prioritize those debts that have higher interest rates since these rates represent the amount of money that you have to pay for the privilege of using these debt sources. Creditors may be willing to offer more favorable rates or an incentive for making large lump-sum payments. Contact creditors while continuing to make normal payments to learn about any money-saving offers they may provide.
Open a College Savings Plan
It is important that individuals place themselves on firm financial footing and consider their retirement years before they tend to college savings for their children. This is because children will have various options available to pay for college, such as loans, grants, scholarships and work-study options. However, financial institutions will not fund people’s retirement years. However, if these issues are already being addressed, a good way to invest a tax return is to open a college savings plan. One option is a 529 college savings plan which provides tax free distributions so long as the funds are used for appropriate educational purposes.
A Note on Tax Refunds
When individuals receive a tax refund, they have basically provided a tax-free loan to the government. Rather than receiving tax refunds, individuals may wish to adjust their income withholding so that only minimal refunds are received and then adjust spending, saving and debt repayments during the year.