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Spending Smart with Your Tax Rebate

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Gregory Karp helps you decide whether it's best to spend your tax rebate yesterday (pay off debt), today (have some fun), or tomorrow (put it into savings) with these tips on Spending Smart.

Spending Smart is not about being a cheapskate. It's not some "live cheap and die loaded" plan, or an exercise in financial anorexia. I don't want to tell you how to make sweaters from dryer lint or how to separate two-ply toilet paper into two rolls. No, spending smart is about spending on purpose, rather than by accident and habit. It's about plugging the leaks of wasteful spending, and redirecting that money to things you truly care about.

Spending smart with your tax refund or rebate is a prime example of how you will be better off if you spend that money with a purpose.

First, let's talk about that tax rebate you'll be getting from Uncle Sam. Single people making less than $75,000 would get a rebate of up to $600. Couples making less than $150,000 would get rebates of up to $1,200. In addition, parents receive rebates of $300 a kid.

So, between the tax rebate and the usual tax refund that many American households get, many people could be looking at a windfall of about $5,000. That's not chump change. But what should you do with that money?

You could deposit the money in your checking account and whittle it away on who knows what by accident or habit. Unfortunately, this is what I predict most people will do. Unless you make a conscious decision to do something different with the money, you'll use this tax windfall like all the rest of your money, probably in the same proportions. The other choice is to spend it on purpose, which will likely provide you with greater satisfaction.

How can you spend on purpose? One idea is to build an emergency fund. A rainy day fund is one of the most fundamental of financial moves. The most obvious benefit is that it provides cash for emergencies: car repairs, medical bills, plumbing leaks, etc. But it can also save you money. With a cash cushion, you can feel comfortable saying no when a sales person offer you an extended warranty because you have the money to pay for the repairs. You can call your insurance agent and raise deductibles on your home and auto insurance, which will save you money on premiums. Maybe an emergency fund's greatest value is providing peace of mind, which any financially stressed out person will tell you has a real dollar value. Your tax rebate or refund will be a great start towards an emergency fund of 3 to 6 months of bare bone expenses. That's what I recommend.

Another thing you can do is pay off debt! You'll get the biggest bang for your refund buck if you finish paying for things you've already bought. You'll avoid those nasty interest rate charges, especially on high-rate credit cards. There are different schools of thought on how to prioritize paying off debt. Math says that you should pay off the highest interest rate first. But most people would be better off paying the smallest debt first. That way, you can finish a few debts quickly, which feels like an accomplishment and provides an incentive for continuing to pay off debt. It's like starting a diet and losing a few pounds right away. It gives encouragement to continue. I especially like a hybrid plan that combines those two ideas. Pay off debt of less than $1,000 from smallest to largest. Get those small debts out of the way. For debts over $1,000, pay off those from highest interest rate to lowest. Also, be sure to attack all of your other debts before you think about paying down your mortgage, which should have a low interest rate and should provide a tax deduction. Paying off your house is fine if that's what you want to do, but it's a low priority compared with other debts.

Another idea is to save. I know, I know, I can hear the collective groan. But think about it this way. Saving is nothing more than deciding to spend your money later, rather than now. Saving for retirement is a good idea, preferably in a Roth IRA. Do that before you save for children's college expenses. You can get loans to pay for college if you really them, but nobody is going to lend you money for living out your retirement years. I also like the idea of starting a car fund. You will replace your current vehicle; it's just a matter of when. Placing a big chunk that that tax refund into a separate account and setting up an auto-deposit of around $200 per month puts you on the path to buying your next car with cash. Paying cash is a fantastic idea. At the very least you can limit the amount you borrow.

And don't forget to have some fun! All work and no play makes Jack a dull boy. Set aside 10% of your Uncle Sam money to have fun. I'd recommend spending that money on an experience. Go to a concert or take a weekend getaway with family or friends, instead of spending it on more stuff like electronic gadgets. Why? Because spending on experiences will make you happier. Academic research has found time and again that spending discretionary money on positive life experiences makes us far happier than spending money on things.

At the end of the day, money is only good for one thing: spending. The key is "when" you spend it. You can spend it yesterday, today or tomorrow. Spending it yesterday is a way of paying off debts for things you've bought in the past. You can spend it today, which includes your spending on fun money and other current expenses. Or, you can spend it tomorrow, which is saving the money to spend later. Most important, whether you spend the money yesterday, today or tomorrow, spend it on purpose. That way, you'll be spending smart.

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