How Not to Spend Your Tax Refund

How Not to Spend Your Tax Refund

If you’re like most Americans, you will be receiving a tax refund this year. If your refund is anywhere near the average it means you’ll 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 isn’t chump change in this struggling economy.

This can certainly be a welcome boost to your bottom line, but it’s 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 isn’t out of the ordinary given the high unemployment and economic climate. But the next highest item on the list is new clothes. I don’t know about you, but when I’ve been out in public I don’t 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 isn’t 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 ‒ I’m sure this goes without saying, but when you get that refund check in-hand don’t 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 “free money” it’s 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 ‒ As much as you want one, don’t buy an iPad, HDTV, or fancy new computer. Here’s the thing. If you couldn’t afford one of these items before the tax refund padded your bank account, you can’t afford one now. Just because the money is available it doesn’t 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 ‒ Again, if you couldn’t afford a vacation without the refund, you’re 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 don’t take enough time off, but a large tax refund shouldn’t be the reason you take one. If you want to go on vacation, by all means do so, but don’t 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 ‒ 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 don’t 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, you’ll 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 ‒ This one gets people more often than they realize. Many people get their tax refund and don’t rush out and spend it on any one big ticket item and instead it just goes into their checking account and sits. If you aren’t blowing it on something you don’t need that’s 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 don’t do anything in particular with the money it will just get whittled away and before you know it you’ve spent an extra few thousand dollars and don’t 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 don’t 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 isn’t 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 it’s true and it’s 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 you’re living paycheck to paycheck that can provide a healthy cushion, help you avoid any late fees, and reduce your overall stress level.

If you’re not in such a dire financial situation that extra $250 a month could still be incredibly helpful. That’s extra money that could be applied to lingering high-interest debt, it’s money that could be going into savings each month,  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, it’s your money so don’t 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 isn’t to make you feel bad about how you were going to spend your refund but it’s meant to illustrate how costly it can be if you don’t 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 isn’t the way to go about it. So, it’s 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 ‒ Above all else, if you’re 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 ‒ This is probably the least sexy way to spend a tax refund, but it’s so important to have an emergency fund. If your debt isn’t much of an issue but you don’t 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 you’re able to pay for it stress-free and not rack up debt to get you through a bind you’ll 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 ‒ Almost everyone needs to save more for retirement because as a whole, this country isn’t saving enough. If you don’t have a mountain of credit card debt and have some money set aside for an emergency and you aren’t already maxing out your retirement accounts, you should really divert some money to the future. Sure, I’d 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 you’re 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), you’ll get a tax break on your tax refund as an added bonus.

Other savings goals ‒ If you’ve 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 ‒ Finally, investing a little in yourself can provide the greatest return of all. If you feel as if you’ve 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 you’ve been meaning to do for ages, or maybe even attend some continuing education or enrichment classes. For example, if you’ve 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.

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