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Q. My husband and I have just inherited about $12,000 from a relative who passed, and we don’t know what to do with the money. Should we pay off the $4,000 in credit card debt we have? Pay down the mortgage? Invest the money in the stock market? Or just keep it in a savings account for a rainy day? I never thought having a windfall could be so stressful. Sarah in Georgia
This is the kind of stress everyone should have, Sarah! Seriously, though, when you consider the options, the decisions are fairly easy…
1. Get rid of that credit card debt! This is an absolute no-brainer. If you have a typical credit card, the interest rate you’re paying is probably around 15 percent. Paying it off is like earning 15 percent, tax-free with no-risk – something virtually impossible to do. So paying off that $4,000 is definitely priority one. Here’s a news story I did comparing paying off debt to investing: Investing vs Paying Credit Card Debt.
2. Save for a rainy day. If you don’t have an emergency fund already, sock away enough to cover at least six months of your living expenses. Keep it safe in a savings account or a money market account: you’re not going to get much in the way of interest, but be sure and shop your rates to make sure you’re earning as much as possible.
3. Invest in the stock market. If you have your emergency fund covered and can afford to tuck this money away for at least five years, you might want to consider the stock market. The stock market requires more knowledge than other types of investments, and you have to be able to deal with the risk, but it’s also the potentially most rewarding. And I think your timing could be good – see this recent article explaining why I think stocks may do well over the next couple of years: Why You Should Buy Stocks and Houses Now. If you’d like to see the stocks I own personally, check out my portfolio.
4. Pay down your mortgage. Mortgage debt isn’t as bad as many other kinds, because interest rates are typically lower and the interest you pay may be tax deductible. That’s why although I hate virtually all debt, I do have a small mortgage. That being said, having a debt-free home is one of life’s most rewarding accomplishments. And paying extra on your mortgage is a great way to get there – I explain it in this video about deciding whether to pay down your mortgage or invest: Paying Down Mortgage vs Investing.
Q. I got a tax extension, and now my taxes are due Oct.15. But I’m still not done. Should I keep trying to do it myself? If I hire someone else and they screw it up, does the IRS go after them for me? Does the IRS have a list of approved tax preparers? I’m freaking out because I don’t want to get audited. What should I do, Stacy? Andrew in California
First, take a deep breath. It’s going to be OK – and Oct 15th is still a long way away.
Let’s start at the end: If you made less than $200,000 last year, your odds getting audited are only about 1 percent. There are certain triggers for an audit, and I discuss them in Odds of an IRS Audit. But the bottom line is: If you’re a typical taxpayer and you report your income and expenses properly, you probably won’t get audited – and even if you do, you probably won’t get in trouble.
As for who does your taxes, the IRS doesn’t care and doesn’t make recommendations. If you have a lot of complicated deductions, it might make sense to go to a pro, or at least use tax software. Check out this story about using software vs. a pro Tax Pros: Getting What You Pay For. But here’s a quote regarding responsibility from the horse’s mouth:
“Whether you select a professional or do it yourself, you are ultimately responsible for what’s on the return,” says Mike Dobinski from the IRS. He says the most common mistakes are simple things like leaving off your Social Security number. But others include not grasping concepts like the earned income tax credit. Check out The 7 Most Common Tax Mistakes.
Follow all this advice, Andrew, and your tax stress will disappear – until next year!
Stacy answers readers’ questions every Friday. Want him to answers yours? Submit them here.