Dear Liz: I’m expecting a bonus this year of about $10,000. Should I pay off $6,000 in back taxes on which I’m currently paying $428 per month on a never-ending installment agreement? Or would it be better to pay off one of our $5,000 credit cards accruing 19% to 22% interest?
Answer: You didn’t mention some important factors: How much you owe on the credit cards, what the interest rate is on that installment agreement, or why you’re planning to use only about half of your bonus to pay off debt instead of at least 90% of it.
What is clear, though, is that you’re having some trouble living within your means. A fee-only planner who charges by the hour could help you figure out a budget. Online resources such as Mint.com or personal finance software such as Quicken or You Need a Budget also might be helpful. Another low-cost source of help would be a credit counselor affiliated with the National Foundation for Credit Counseling (www.nfcc.org).
All things being equal, it’s usually best to pay off your highest-rate debts first. If you owe so much on credit cards that you have no hope of paying them off within five years, however, you might be wise to spend some of your bonus consulting a bankruptcy attorney.
My own impulse would be to pay off the tax bill. I don’t know what interest rate the writer is paying, but there is interest charged on tax bills, and I would prefer not to owe the government money. Then I would use the rest, if income taxes have already been withheld from the bonus, to pay off the highest-interest credit card. Then I’d cut up the cards, or at least freeze them in a block of ice!