Ah, the holidays -- a time for giving, receiving, and most likely overspending. In a recent survey, 56% of Americans admitted they're planning to rack up debt this season, 16% of which expect it to take six months or more to pay off.
So, just how much does the average American spend on holiday gifts? According to the American Research Group, U.S. shoppers anticipate spending an average of $929 this season. Talk to parents, though, and you might see that number climb even higher. Newly released T. Rowe Price data confirms that parents are spending an average of $422 per child on holiday gifts, with 34% of parents spending $500 or more per child.
Worse yet, an alarming number of parents are putting their finances at risk to make their kids' holiday wishes come true. An estimated 25% are taking drastic measures such as withdrawing money from their 401(k)s, dipping into their emergency savings, or taking out payday loans in order to purchase holiday gifts. And while a fair number of parents understand the importance of creating a holiday budget, a good 58% of families fail to actually stick to one.
No matter how much you earn and who you're shopping for, it's critical that you adhere to your holiday budget and avoid going overboard. Otherwise, you run the very real risk of getting in way over your head.
How much will holiday debt cost you?
It's one thing to reach into a savings account and pull out the money you've been stashing away all year long to pay for holiday gifts, but whipping out that credit card is a whole different story. Any time you use a credit card and fail to pay it off when your bill comes due, whether it's a $10 charge or a $1,000 charge, you're automatically signing up to throw away money on interest. And the longer you carry a balance, the more money you'll waste.
Imagine you wind up spending $929 on holiday gifts this year like the average American, and that you're forced to put all of your purchases on a credit card charging 18% interest. If it takes you a year to pay off that debt, you'll wind up spending $1,022 in total -- that's almost $100 thrown away in interest. Carry that balance an extra year, and you'll waste $184 on interest charges. While there are plenty of good reasons to pay with plastic this holiday season, remember that credit cards are a dangerous thing when you don't have the money to pay them off right away.
Don't touch that emergency fund
Another big mistake shoppers make around the holidays is pulling money from emergency savings. Your emergency fund is designed for -- wait for it -- emergencies, like your car breaking down or your roof springing a leak. Ideally, you're supposed to have three to six months' worth of living expenses stashed away in case you lose your job, fall ill, or encounter another scenario where you have bills to pay and no income coming in. If you take money out of your emergency fund to pay for holiday gifts, you risk coming up short if a true financial crisis hits you down the line.
Leave your retirement savings alone
No matter how badly your child or grandchild wants that $300 motorized race car, do notmake the mistake of reaching into your retirement account to get the cash. First of all, if you're under 59-1/2, you'll be penalized 10% for taking an early withdrawal from a traditional 401(k) or IRA. On top of that, you'll be taxed on whatever amount you pull out -- so if your effective tax rate is 25% and you take out $900 to pay for holiday gifts, you'll actually be liable for an additional $225 in taxes.
But perhaps the biggest reason not to take money out of a retirement account is that you need that money for retirement. And when you withdraw money early, you don't just lose the amount you cash out; you lose out on the opportunity to let that money grow. Say you're 30 years old and you take $900 out of a 401(k) to cover your holiday spending. If your investments otherwise generate an average annual 7% return (which is slightly below the stock market's average), that $900 could turn into $9,600 by the time you're 65 -- which means that taking it out could set you back big time for retirement.
It's easy enough to overspend during the holidays, so rather than charge up a storm or tap into savings you shouldn't be touching, try putting a little bit of cash aside each month in advance. Granted, it's probably too late to take that approach this year, but it's something to think about going into 2017.
Furthermore, if you're going to map out a holiday budget, for the love of Santa, make sure you stick to it. If you estimate that you can afford to spend $500 this holiday season and not a penny more, withdraw $500 in cash, take that amount with you when you go to shop, and leave the rest of your wallet at home.
Finally, if you're really strapped for cash this season, remember that it is the thought that counts. It's noble to want to shower your friends and loved ones with presents galore, but it's not worth letting your finances take a beating in the process.