What To Do With Your Tax Refund?

Congratulations if you happen to be one of the fortunate taxpayers to receive a tax refund this year! The typical refund averages around $3,000, an amount that isn’t exactly chump change, and you’re probably wondering what you should do with all that money.

We suggest that you take the time to evaluate the recommendations below, and then develop a plan for what you’re going to do with your refund.

Before getting started, it’s worth pointing out that the reason you received a refund in the first place is because you overpaid your taxes to the government during the year. In effect, you made an interest free loan to the government for the amount of the refund. In order to avoid making another loan of this sort in the future you can adjust, or lower, the amount of withholdings taken out of your paycheck every pay day and end up at the end of the year at a more break-even level with what you owe.

This being said, some taxpayers want to have something to look forward to in the form of a refund or forced savings that creates the sense of a bonus to look forward to at the end of the year. The following choices assume that the taxpayer likes the forced savings/quasi-bonus approach and doesn’t care to break-even on their taxes.

• Set up an emergency fund to help get through those rough times when an unexpected emergency situation arises. Establish an emergency fund by depositing all, or a part, of the refund into an interest bearing savings or money market account that permits easy access to your money when the emergency arises.

• Pay off debt. Some experts recommend that after establishing an emergency fund, the next best thing you can do with your tax refund is to reduce or eliminate any high-interest debt that you’re carrying. Put your refund to work by paying down debt that carries interest at a rate that is greater than what you can earn in interest elsewhere. The trade-off between eliminating high interest debt with low interest earning investments is literally a moneymaking proposition.

• Don’t just deposit the refund into a non-interest bearing checking account and let it sit there for “safe keeping.” In this scenario the refund is sitting idle not earning at least some interest. Deposit the refund into an interest bearing savings account or money market account that permits easy access to the funds as needed.

• Loan the funds to friends or family with the expectation that the loan will be repaid. Of course, with all due respect to friends and family, making loans to them is a high-risk proposition. These sorts of loans seem to have a higher risk of not being repaid. If the risk of not being repaid is something you can live with then proceed with making the loan. However, if you are counting on the loan being eventually repaid and you need to have the funds then do not make the loan.

• As noted here, start an individual stock investment account. This is a good way to get very familiar with the stock market and individual stock investing, Start small. Perhaps invest some amount that is less than your total refund. This kind of investing carries substantial risk, but has the potential for substantial reward.

• Start that business you’ve always dreamed about. As Kiplinger notes, with the average rate of $3,000 per refund, it might be possible to cover those start-up costs that will put you over the threshold that needs to be incurred to get that business started. Very successful businesses have been started in garages and home offices for far less of an investment.

• Treat yourself to a vacation. There’s nothing wrong with using your refund to do something really special that you’ve only dreamed about doing. $3,000 can go a long way toward paying for a vacation to some exotic destination, someplace special, without having to go in debt to pay for it. It’s called being good to yourself. Think of it as a vacation paid for by Uncle Sam! But make it really special and do it before you spend your money on unnecessary day-to-day operating expenses, which will always be there.

• Make an extra payment on a student loan. It seems like amounts owed on student loans will never go away. These loans typically carry interest rates that are at the high end of the interest rate spectrum so that making an extra payment is not only a profitable strategy but will help get rid of these loans sooner.  

• Contribute to an IRA. It doesn’t hurt to fund next year’s IRA contribution sooner rather than later so why not do it now and then forget about it next year when tax time is upon us. It’s almost like experiencing the sense of a “free contribution” because the contribution is being funded with a tax refund, even though the refund was from your own money in the first place.