The plans of the diligent certainly lead to profit as surely as haste leads to poverty. (Proverbs 21:5)
The IRS reports that the average refund for the 2018 tax year was approximately $2,800. Whatever refund amount you receive this year, don’t blow it!
You may be tempted to “treat” yourself to something you’ve wanted for quite some time. However, now is the time to pause and think about the best way to spend or invest your refund. Examine your “wants” vs. your “needs.” Below are some things you might want to consider doing with your tax refund:
- Pay off your credit card and other debt. Think about it: The quicker you pay your debt, the more money you’ll free up. If you’re paying $225 a month in debt payments, in one year you will have paid $2,700. Applying your refund will bring you one year closer to becoming debt-free.
- Invest in your retirement. You may think retirement is so far off that you have time to prepare. If you ask most soon-to-be retirees what they wish they had done differently to prepare for retirement, the resounding response is that they wish they’d started earlier and contributed more. The earlier you start saving, the better off you’ll be. If you invest $2,800 in a retirement savings account, such as a Roth IRA, with an average return of 10% (historical S & P 500 return), in just 10 years, your $2,800 will be worth $7,579. If you let it sit for 20 years, assuming the same rate of return, that one-time investment would be worth $20,518. If you plan to contribute an additional $100 per month, in 30 years, your nest egg could be worth $281,549. Imagine that!
- Establish your emergency fund. It’s been reported that most (over 50%) of households have less than $1,000 in savings. And 34% have zero. This means they are ill-equipped to handle most emergencies without going into debt. Ideally, you want to have at least three to six months of expenses saved up to cover situations that might significantly decrease your income, such as a job loss. However, an initial emergency fund of $1,000 (while you’re paying off any debt) should be sufficient to cover most short-term emergencies, such as a car repair.
Something you also should consider is keeping more of your money throughout the year. When you get a tax refund, you have essentially loaned the IRS your money and you’ve earned no interest. The IRS is simply returning what you overpaid—dollar for dollar. If you’re receiving a large refund, you’re missing the opportunity to grow those dollars through savings and investments which earn compounding interest.
For example, if you’re receiving the average refund of $2,800, that works out to $233 each month from your paycheck that sent to the IRS for “safekeeping” until tax filing season. Think about how you could use the $233 each month, as opposed to waiting to get it all at once when you’re more likely to treat it as a bonus or windfall and perhaps spend it in a manner that does not advance your financial goals. If your goal is to pay down debt, adding $233 to your monthly payments would significantly reduce your debt balances more quickly.
The number of allowances you select on your Form W-4 determines how much the IRS withholds for taxes. The more allowances, the less tax is taken out of your pay. The link below provides a Tax Withholding Estimator that calculates your actual tax liability so you can better gauge whether your allowance may need to adjusting. You should also consider consulting a financial planner or tax consultant for personalized advice:
I know it’s exciting to get that tax refund. Many people I speak with are aware that they can make allowance adjustments, yet they prefer getting a large refund. They consider it a forced savings plan or bonus of sorts. If you choose to continue receiving the big refund and you feel like you need to treat yourself, go ahead and do that—but don’t go overboard. Take this opportunity to get ahead. Make small sacrifices and use your refund to jump-start a better financial future.