Tax Refund Your Way Out of Credit Card Debt

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By Nancy Castleman

Over 100 million U.S. taxpayers got a refund on their taxes last year, averaging $2,171. According to the IRS, it's likely that a similar number of folks will get refunds this year. So if you're eagerly awaiting a nice, lump sum from Uncle Sam, you have lots of company.

As you wait for this year's check, ponder this: All those refunds you've gotten over the years were actually interest-free loans to the federal government! You earned zilch on those dollars, while at the same time, you probably paid interest on at least a few credit card balances.




Instead of letting Uncle Sam use your money interest-free, look at what happens when you use your refunds to get out of credit card debt. Say you owe the current average credit card balance of $9,312 on a card charging 17%. If you only send in the required 3% minimum payment every month, that card will cost you $17,465 by the time you pay it off, over 21 years from now - assuming you don't charge anything else.

Now let's assume you get a tax refund amounting to last year's average of $2,171. If you send it in as a lump sum payment against your credit card balance, you'd cut the cost down to $15,524, saving $1,943 in interest, and you'd be out of hock in under 20 years.

Go for the Double Whammy

To really ramp up your savings, continue to use what would have been future tax refunds to pay off your debt. First step: Change the number of dependents you claim on your withholding at work, so the amount you pay the IRS better reflects what you owe. In this example, that'd give you $180.91 more a month.

Send that amount in every month along with the required payment on your credit card bill, and you'll slice your costs dramatically - to $10,777.67 for our $9,312 sample debt - and the entire bill would be paid off in less than three years. Your total interest savings would be $6,689, and there would be over 18 years of payments you won't have to worry about getting to the bank on time!

To further inspire you, I tried to get estimates of the expected refund amount for this and future years, but I got nowhere! The reason, according to the IRS as well as other tax experts is that there are too many variables to factor in - plus there have been some changes in tax law.

According to Cindy Hockenberry, Tax Information Analyst for the National Association of Tax Professionals (NATP):

"The rules for claiming the earned income credit and head of household filing status based on a qualifying child, have been tightened. Some taxpayers who were able to maximize tax benefits last year can no longer benefit from them. Here is an example:

A 25 year old taxpayer lives with a parent. The parent provides over half the cost of the home the two of them live in. The taxpayer earns $30,000 a year and the parent earns $40,000 (the income really doesn't matter). Last year, the parent could file using the head of household status. This year they have to file as single because the taxpayer is not under age 19, or under 24 and a full time student. The result (assuming income and other deductions stay relatively the same) is that the parent has a lower refund."

Changes at home can also dramatically change the amount of a refund. Here's an example of some good tax news, again courtesy of Cindy Hockenberry:

"Taxpayers who had no children in 2004 and now do in 2005 will automatically have a $1,000 savings in tax."

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By Nancy Castleman is a Consumer Reporter for CardRatings.com