Who doesn’t love a good refund? There’s the kind you get when you return a shirt to the mall or complain because the Wi-Fi wasn’t working on your cross-country flight. And then there’s the kind that can really make a difference in your annual budget and help you reach some important financial goals: The tax refunds that come once a year from the IRS.
For the 2016 tax year, the average refund per taxpayer was around $3,000. That’s a significant chunk of change that can propel you towards your career goals by offering additional security as well as enable you to pursue new business opportunities — but only if you use it correctly. In other words, “don’t go buy a high-end espresso maker for the office,” says Andrew Oswalt, tax analyst at TaxAct. If you’re self-employed and expecting a windfall from Uncle Sam, here are five great ways to put your refund to use.
1. Boost your retirement savings
Whether you’re a one-person show or you have several employees, boosting your retirement savings is always a good move. Just six in 10 workers have saved for retirement according to the Employee Benefits Research Institute. An easy way to start? Open and fund a traditional IRA or Roth IRA. Either will allow you to contribute $5,500 a year (plus another $1,000 if you’re 50 or over.) With a traditional account, you’ll get a tax deduction for making your contribution and pay income taxes at your current rate when you withdraw the funds. You don’t get to write off your deduction with a Roth, but withdrawals will be tax-free.
IRAs are only one option, however, and if you’re looking to save more than they allow, you may want to consider a SEP (Simplified Employee Pension) IRA. With a SEP IRA, you can save up to $55,000, or 25 percent of your net self-employment earnings. The only catch? If you have employees, you have to make the same contributions into an account for them that you make for yourself. So, if you elect to make a contribution that’s 5 percent of your salary, and you have two employees, you’ll need to contribute 5 percent of each of their salaries to their plans.
If you don’t have any employees, you can also consider a solo 401(k), which also has a limit of $55,000 in contributions. Note that if you and your spouse work together, your spouse won’t count as an employee, and you can still take advantage of a solo 401(k). Also, if you’re over 50, you’re eligible to contribute another $6,000 per year, bringing your total up to $61,000.
“The goal of going with a solo 401(k) or a SEP IRA would be the much higher contribution limits,” Oswalt says. “If you’re just starting out as a freelancer or working side-gigs, then you may not be able to save more than $5,500, and that’s fine. But if you’re established, and you’re looking to save as much as you can for retirement, then it may be time to step things up and look at an account with a higher limit.”
2. Invest in your business and prospective clients
Would it benefit your business if you could travel to recruit some new clients? What about attending a conference or investing in some new office furniture? Your tax refund can help you with all manners of business growth goals.
“Look at what you want to do in the near future and in the long term,” Oswalt says. “You could create a travel fund, a research and investment fund, a technology fund; you name it.”
In today’s tech-driven world, small business owners also have to think about — and invest in — their website and social media presences. “Everything’s online. Having a nice website is just the cost of doing business these days. If I’m looking to hire someone and they don’t have a website, that’s a red flag to me,” Oswalt says. “Building your online presence is a good expense to have because you’re setting yourself apart.”
3. Build up your emergency fund
An emergency fund doesn’t just serve as a saving grace in the case of an urgent event — it can also work wonders for your peace of mind as a business owner. “You never know when your business is going to have plumbing issues or when your equipment might break,” Oswalt says. “If you’re a photographer and your $2,000 camera breaks, it’s nice to have that [just in case] fund built up so that you don’t have to skip a beat on business.” Even if you have [property and casualty] insurance, he adds, it’s good to have an emergency fund to put towards your deductible, which isn’t always affordable.
So how big an emergency stash do you need? Chances are more than you have now. Close to six in 10 Americans would have less than $1,000 saved to sustain them, according to a new GOBankingRates survey. An ideal emergency fund contains three to six months’ worth of expenses, but the few thousand that comes in most refunds is enough to cover many unplanned urgencies. Consider it your starter cushion and build from there.
4. Pay down debt
If you’re self-employed, it’s highly likely that any credit card debt you’ve accrued is at least somewhat attributable to your business, Oswalt says. Using any refund as debt relief can be a stress reducer and a smart business move. Think about it this way: The return you get from paying off debt is equal to your card’s interest rate. With the average credit card APR at more than 16 percent, you’re basically putting $480 in your pocket when you use a $3,000 refund to pay off debt. Your next move, however, should be to try to wall off those business expenses. “A lot of people don’t have a credit card that’s solely for business purposes,” Oswalt says. “My recommendation would be for people to get a business card in order to track their expenses.”
5. Prepay what you’ll owe in taxes next year
Finally, it’s okay to go ahead and apply part or all of your refund towards next year’s taxes, Oswalt says. Your tax software will likely prompt you to make the decision while filing, and you can elect to apply your refund to your next quarter or all of the upcoming quarters. That way, instead of having to plan for what you’ll owe in April, June, September and January of the following year, it’ll already be taken care of. If you already filed without that option? You can still set aside the cash in a savings account labeled “Tax Payments,” then pull from that for quarterly payments or the next filing season.
With Hayden Field and Kathryn Tuggle
Source : TaxAct Blog