Tax Refund? Use It Wisely
Tyler Day | April 15, 2024
Think twice about fast cash.
Managing unexpected money can be difficult. Often the “free money” is seen as an excuse to splurge for something that you otherwise wouldn’t. 67% of taxpayers receive a refund, with the average refund totaling $2,753. But for most, that money is gone in the blink of an eye. But what if there was a better way? What if you could use your tax return this year to set you up for long-term financial success?
Reframe your thinking
Most people view a tax refund as free money given to them by the government. This thinking allows the tax refund to be in a separate mental category as money that was earned at work. The thinking is that earned income is something to be responsible with, tax refunds are free and meant to be splurged.
Looking closer at what a tax refund actually is allows for a change in mindset. Tax refunds are only paid out when you paid too much in taxes throughout the year. The money that you get back in a tax refund is your hard-earned money that the IRS held onto for a little while (interest free nonetheless!). This is money that could have gone to any number of “responsible” things throughout the year. Why should it be any different now that the government has returned what you overpaid?
Pay off credit card debt
It is well known that interest on credit card debt is more extreme than most other kinds of debt. Yet the average credit card balance is $6,501. While the average tax refund won’t eliminate that level of debt, it is a good starting point on the journey to becoming debt free. Any additional money that can be put towards paying off debt of any form could save a significant amount of money in the long run. Avoiding credit card debt altogether is the best strategy. That is where Emergency Funds come in.
Bolster your emergency fund
The prevailing recommendation is for every household to keep an emergency fund with 3 to 6 months of take home pay. When was the last time you added money to your emergency fund? Have you replenished it since that surprise car repair bill last fall? Do you even have an emergency fund? Most American households don’t. Only 44% say that they would pay for a $1,000 emergency with money from their savings. The rest provided some other sort of “solution” like credit cards, personal loans or borrowing from friends or family. Keeping an emergency fund is often the difference between using your money to grow wealth and falling into the trap of credit card debt. Using your tax refund to start or maintain your emergency fund is one of the most prudent uses of the “free money.”
Pro Tip:
Emergency funds are useful tools, but less effective if they are used for purchases that aren’t truly an emergency. Add another barrier between you and your emergency fund by holding it at a different bank than your normal checking and savings accounts. For more of a boost, use a bank that offers high interest rates on their savings products
Save for your long-term goals
Once you are free from high interest debt and have fully funded your emergency fund, you can start to consider using your tax refund on the things that are truly important to you. Everyone has financial goals that they would like to achieve. Some common goals to consider are:
Student Loan Repayment
Starting a Family
Retirement/Financial Independence
Starting a Business
Children’s College Fund
Home Purchase/Renovation
Vehicle Purchase
All of these goals, and many more, are worthy of consideration. While slow & steady saving is often the best way to achieve these goals, an annual boost from your tax refund will never hurt your progress.
Splurge on you
After all this talk of being responsible with your money, the last recommendation is to splurge a little bit on yourself! However, this isn’t the uncontrolled spending that most succumb to this time of year. Set a limit for yourself. Use 10% of the tax refund that you’ve received on something that you will really enjoy. This could be a nice dinner with your spouse, an experience with your kids or a new item for one of your hobbies. The idea here is to reward your disciplined responsibility over the other 90% of the refund with something that you can look forward to.
Still don’t know how to use your tax refund?
Or are you hoping to save on taxes and potentially get a larger refund next year? Maybe you are more interested in reducing lifetime taxes and not just focused on this year? Financial planners are well equipped to answer your tax planning questions as well as questions on other areas of personal finance. Some even offer a comprehensive financial plan for less than the average tax refund. Schedule a free consultation with Tyler Day, founder of Foresight Financial Planning
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