This week, the Internal Revenue Service of the United States will begin sending direct deposits to those who qualify for the economic stimulus tax payment and checks soon after. Everyone who is interested in the tax ramifications of this payment should now know that the money received as a result will not be counted as “income” for federal tax purposes and that the payment is an advance of a new credit introduced for 2008′s income tax calculations.
The way I see it, the question in the minds of many is more immediate: What should we do with our stimulus payment? This deposit of $300, $600, or more is in some ways an unexpected gift. Though some could rightly argue that it is simply more of our own money returned to us, it is unexpected and thus not planned for. Some could also argue that it is wealth redistribution, as some low-income taxpayers may receive a payment larger than their total tax liability for 2007. (Note that the government changed their terminology for this program in March from “rebate” to “payment.”)
Regardless of opinions, here are some of the more popular options for dealing with an unexpected sum, either from the government or from any source.
If you have high-interest credit card debt, consider using your found money to reduce your interest payments. Credit card debt is an unnecessary expense. Unless you have an introductory rate or a special deal, chances are that you cannot earn a higher rate of return in an investment, particularly a liquid investment, than what you are paying in interest. Reduce your total debt and your interest payments by applying the total amount of your stimulus payment towards the balance on your credit card with the highest interest rate.
If you’re taking on the debt avalanche (a method mathematically superior to the snowball method), your payment will go far towards reducing your total debt.
If you have a mortgage on your primary home, consider making an extra payment to your principal this month. While it’s unlikely to make a noticeable dent in the short term, even one extra payment will reduce your total spent on mortgage interest significantly over the next few decades. To illustrate, a $500,000 loan over 30 years, starting June 1, 2008, with an interest rate of 7%, will benefit from a $8,400 reduction in total interest paid over the life of the loan if an extra payment of $1,200 is processed on June 1.
If you have no immediate savings, consider depositing the payment in a high-yield savings account. This is an important step to building a tiered emergency plan. While this money may not earn as much return over time as an investment in the stock market might, having funds available in a semi-liquid account allows you not to dip into debt as quickly or sell investments incurring fees and tax consequences.
You can count on an emergency arising at some point, and it’s advisable to be prepared.
If you are debt-free and you have an emergency fund, consider devoting this money to retirement. Saving for the future will increase the possibility of having the ability to stop trading your time and effort for money. In other words, if you’d like to retire from working someday, you’re going to need money to sustain your ability to pay for your expenses. Money invested in the stock market now has a good chance of earning a good rate of return when your time horizon for needing the income is several decades away.
I suggest opening a Roth IRA with Vanguard, invested in VTSMX, the Vanguard Total Stock Market Index Fund. (And no, they don’t pay me for this recommendation.) The fund has a low fee and a low barrier to entry for Roth IRAs.
If you have a Roth IRA, you can invest this money in your 401(k). This option isn’t as straightforward as sending a check to your 401(k) custodian, though. You can’t just deposit money into your 401(k) as you would be able to with another investment account. You’ll have to temporarily increase your 401(k) deferment by the amount of your stimulus payment and then reduce your deferment afterward. Assuming you’re not already maximizing your 401(k) contributions, this is a roundabout method of investing your found money in an tax-deferred account.
If you are set for retirement, consider saving this money for your children or other relatives to help pay for higher education. I haven’t decided whether I am a fan of 529 accounts which only offer tax-free earnings when funds are withdrawn for educational expenses (and in some cases, the rules are strict about which schools’ expenses will qualify), but helping to pay for education — so your children don’t have to work as much during the time they should be concentrating on learning — will be beneficial for their future earning potential.
And if you plan on growing old, your children’s future earning potential may be quite relevant. They may have to help support your health in your later years.
If you have no saving or investing holes to be filled, consider charitable giving. While $300 may not be much to you, there are many organizations who would be happy to receive the money to help fund a program. This is a highly personal decision, so you should find an organization that has personal meaning.
Religious organizations and churches are popular choices, and some people prefer to support scholarships pertaining to a meaningful field of study. Organizations that support social, arts, and athletic programs constantly require funding. If a health condition has affected your family or friends, chances are there is a related organization supporting research towards treatment and a cure.
All out of ideas? Buy something, either for someone else or for yourself. MyMoneyBlog has some tips on where your money will go the farthest, with several stores offering a 10% bonus on your money when purchasing a gift card or a pre-paid credit card. Watch out for these types of benefits. Often, and where not prohibited by law (ie., California), gift cards lose value over time or charge a fee, reducing your bonus (if any). Some of the stores offering a 10% bonus include Kroger Supermarkets, K-Mart, Sears, and Radio Shack.
In some cases, you have to bring your actual stimulus check to the store to receive the bonus. For those of us who are efficient and will receive their payment via direct deposit, we would not qualify.
The stated purpose of this economic stimulus plan, as devised by both the White House and the Congress, is to stimulate the economy by getting money into the hands of who might spend it, particularly on American-made products. The political purpose is deeper yet more superficial: to ensure that both the Democrats and the Republicans appear to care about the economy as the presidential election draws nearer.
The economy is often a matter of psychology rather than pure financial statistics, so it’s unclear whether these payments will have any measurable effect on the economy. If economic sentiment changes from negative to positive, it’s unlikely that one could prove that the stimulus package would be the cause.
How do you plan to invest or spend your stimulus payment?
Updated February 6, 2012 and originally published April 28, 2008. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.