If youâre like most Americans, you will be receiving a tax refund this year. If your refund is anywhere near the average it means youâll be getting a few thousand dollars. No, really. The average tax return for the 2010 tax year is a little higher than usual and is $3,129 so far this year. That isnât chump change in this struggling economy.
This can certainly be a welcome boost to your bottom line, but itâs not the fact you are getting money that helps, but how you use it. Treat your tax refund carelessly and you might as well have not received any money at all.
So, what are people planning on spending that tax refund on? Capital One has done a survey and the results may be kind of surprising:
- Everyday expenses: 23%
- New clothes: 11%
- Vacation: 6%
- Computers/electronics: 4%
Yikes! There are a lot of people relying on this money to cover the daily bills, and that isnât out of the ordinary given the high unemployment and economic climate. But the next highest item on the list is new clothes. I donât know about you, but when Iâve been out in public I donât get a sense that people are wearing raggedy old clothes and desperately need some money to update their wardrobe. Obviously, moving down the list we all know that spending money on vacations or electronics isnât a very wise use of money, but big-ticket items are always a target for those tax refunds.
What is most shocking is the survey reports that only about 5 percent of those getting a refund will save the money for either retirement or college. And guess what? Those 5 percent are probably the ones who need to save money the least since they are likely already regular savers. Instead, those blowing money on new HDTVs or an expensive vacation are likely to have even less saved.
How Not to Spend Your Refund
Gambling â’ Iâm sure this goes without saying, but when you get that refund check in-hand donât rush out to the casino with dreams of doubling your money. We all know that gambling is a losing game, but when you get what feels like âfree moneyâ itâs easy to have less emotional attachment to it and you may be more apt to blow it on a night of fun. Resist the urge.
Electronics â’ As much as you want one, donât buy an iPad, HDTV, or fancy new computer. Hereâs the thing. If you couldnât afford one of these items before the tax refund padded your bank account, you canât afford one now. Just because the money is available it doesnât make it a green light to spend. Beyond the initial purchase price you have to keep in mind that many gadgets have ongoing costs that really add up. That new iPhone or iPad will cost you hundreds of dollars a year in fees, a new TV or gaming system will mean spending more time being less productive and may entice you to splurge for more expensive programming or monthly subscriptions, etc.
Vacation â’ Again, if you couldnât afford a vacation without the refund, youâre really not in a financial position to be taking that kind of vacation to begin with. We all need time away from work and as a whole workers in this country donât take enough time off, but a large tax refund shouldnât be the reason you take one. If you want to go on vacation, by all means do so, but donât think of the tax refund as a means to do something far more extravagant than you would otherwise. If you do, that money is just going to burn a hole through your wallet in just a short week or two and likely just go to an airline or hotel chain and a few weeks after returning you will have forgotten all about a few of the added perks that cost you an arm and a leg.
A new car â’ If you absolutely need a new vehicle because yours is broken down and you have to rely on others to get around, then maybe you should spring for some new wheels. But donât use your tax refund as an incentive to go buy a new car. Owning a car is incredibly expensive, and while a few thousand dollars to go towards a down payment can ease the pain a bit, youâll still be laying out a ton of cash over time on things like gas, higher insurance premiums, and maintenance. If you are going to buy, shop smart so you can save money.
On nothing in particular â’ This one gets people more often than they realize. Many people get their tax refund and donât rush out and spend it on any one big ticket item and instead it just goes into their checking account and sits. If you arenât blowing it on something you donât need thatâs a good thing, right? Well, not always. In cases like this the money may sit idle and slowly get sucked out of your account without even realizing it. If you donât do anything in particular with the money it will just get whittled away and before you know it youâve spent an extra few thousand dollars and donât even know where it went.
The Wrong Way of Thinking
The problem with the tax refund is that people usually think of it as an unexpected bonus. For eleven months out of the year you donât think twice about taxes, but every spring you sit down to do your taxes and get excited to see a nice chunk of money coming your way. Then your mind wanders and you think about where you can spend it. The money is spent before it even hits your bank account.
Remember, this isnât a bonus. This is simply Uncle Sam giving you your own money back that you otherwise could have already had in the bank. I know the financial world beats us over the head with this every year, but you really should strive to get as little of a refund as possible. It gets repeated because itâs true and itâs so easy to rectify.
Think about it. If you are one of the nearly one out of four people who will spend their tax return on everyday expenses and bills, think of how helpful having an extra $250 coming in every month would have been last year. If youâre living paycheck to paycheck that can provide a healthy cushion, help you avoid any late fees, and reduce your overall stress level.
If youâre not in such a dire financial situation that extra $250 a month could still be incredibly helpful. Thatâs extra money that could be applied to lingering high-interest debt, itâs money that could be going into savings each month, Â it could be enough to help put your kids through college, or it could pay the premiums on that life insurance you desperately need but have put off for over a decade. Whatever the case, itâs your money so donât let the IRS hold it hostage for most of the year. Put it to work immediately and the results will pay off.
Smart Ways to Spend Your Tax Refund
The point of this article isnât to make you feel bad about how you were going to spend your refund but itâs meant to illustrate how costly it can be if you donât spend it wisely. We do need to strike a balance between living for today and saving for tomorrow and it is possible to do both. But spending foolishly just to feel good for a short time while sacrificing your future isnât the way to go about it. So, itâs ok to have a little fun with that tax refund, but before you blow it all there are a few smart ways to spend most of that money. In the order of importance:
Pay down high-interest debt â’ Above all else, if youâre carrying any sort of balance on a credit card you should try to tackle it with tax refund money. For starters, knocking out high-interest debt will save you a boatload of interest. A $3,000 balance on a typical credit card will cost you in the neighborhood of $500-$800 a year in interest alone! Pay off that debt and you basically just made money. In addition to saving money on interest you also immediately improve your monthly cash flow. A lower balance or no balance at all means a lower or no monthly payment on that debt going forward. Now you have more money to spend each month.
Pad emergency savings â’ This is probably the least sexy way to spend a tax refund, but itâs so important to have an emergency fund. If your debt isnât much of an issue but you donât have at least a month or two worth of expenses saved up you really should. Creating an emergency fund is about as exciting as paying insurance premiums, but it pays off more than you can imagine in a time of need. Nobody wants to think about using emergency money, but things can and do happen and if youâre able to pay for it stress-free and not rack up debt to get you through a bind youâll realize how important it is. You can start by opening a high-interest savings account and put your money to work for you.
Retirement savings â’ Almost everyone needs to save more for retirement because as a whole, this country isnât saving enough. If you donât have a mountain of credit card debt and have some money set aside for an emergency and you arenât already maxing out your retirement accounts, you should really divert some money to the future. Sure, Iâd rather spend a week in Europe or get a new plasma HDTV than plunk a few thousand into my IRA, but I have to remind myself of the future. If youâre younger, time is one of your greatest assets, so putting that money to work today will go a long way in providing a better future. Oh, and if you divert your tax refund into a Traditional IRA or 401(k), youâll get a tax break on your tax refund as an added bonus.
Other savings goals â’ If youâve got the three previous items pretty much under control, then think about your other miscellaneous savings goals. Things like saving for college, buying a new car, or a planned purchase of a home. A little bit goes a long way when it comes to college savings, and down payments are more important than ever when it comes to borrowing for big ticket items.
Invest in yourself â’ Finally, investing a little in yourself can provide the greatest return of all. If you feel as if youâve been stuck in a rut or your career is sucking the life out of you, spend some time and money to see how you can improve your quality of life. Find a way to strike a better work-life balance, take a few days off to get something done youâve been meaning to do for ages, or maybe even attend some continuing education or enrichment classes. For example, if youâve always wanted to take up photography as a hobby but never knew where to start check your local community college. Most offer night classes for subjects like that for little more than a few hundred dollars and it will get you out of the house and experiencing something new.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
Jeremy, I underscore your recommendations again and again. If you want to grow your wealth, watch excessive and impulse spending and you must save/invest. There's no other way!
Not an unexpected bonus is exactly right. This was the first year I actually did something responsible with my return.
I have an unbeatable system for increasing my refund: I send the IRS an extra $150, every month, throughout the year. Then, you wouldn't believe how generous they are: they actually give me an additional $1800 every April! Ha, what suckers they are.
(How is that different?)
Out of sight out of mind. Success with money is more about psychology than accounting.
If you're getting a refund, I would recommend deciding with your significant other or someone else that helps us keep our irrational selves in check, what to do with the money before it hits the account. Once you've decided the best place for it, get it out of sight and out of mind. Put it to work so you're not tempted to use it in a way that won't best serve you and your future.
I normally do not get a refund, just break even w/owing the feds a bit and getting back about that bit from the state.
However, this year because of the way my severance was paid I am getting back nearly $3000. I am unemployed so I can:
live off it for nearly 3 months
pay my house insurance + live for a month
pay my real estate taxes
Any one of the above will mean I do NOT have to take that money out of savings and that is what I plan to do.
I think there are alternative ways of thinking about one's tax refund depending on his/her individual situation. My husband and I work hard throughout the year to save money toward retirement, to make sure we've got a good emergency cushion in place, and to fund longer term goals. We live within our means and don't have credit card debt. As long as we're doing that, what's wrong with using part of our tax refund dollars to plan a vacation or two?
I actually am putting mine towards a new car......to be purchased when my current one is ready to be replaced in about a year. The idea is to pay cash for the car and not have a car loan at all :)