We are in the middle of tax season as many of us are starting to do our 2015 tax returns. One issue I think is important regarding taxes that doesn’t get much attention is what to do with your tax refund. Many of us this year are going to receive refunds and as far as I’m concerned, you should have a game plan as to what you do with that refund before you receive it. If you don’t have a game plan, the money will be deposited into your checking account and eventually, it will be gone. That is why I think it is important to have a game plan before you receive your refund so the money is not wasted.
For those of you who are receiving a large refund, the first question you should ask yourself is why you are receiving such a large refund. It may be that you had too much withheld from your paycheck. If that is the case it makes sense to adjust your withholding through work. My philosophy is you do not want to receive large refunds because what it means is that you’ve given the government an interest-free loan. Ideally, you would not want to receive any refund because that would mean you didn’t give the government an interest-free loan. In addition, you don’t want to owe a lot of money because then you have interest and penalties to deal with. Therefore, the goal is to either get no refund or a very small refund. That is why when you do your 2015 tax return it is a great time to adjust your 2016 withholding.
As far as I’m concerned, the number one thing that most people should do when they receive their refund is look for ways to pay down debt. Particularly, high interest rate debt that is not tax deductible, i.e. charge cards. Student loans and car loans are also good uses of a tax refund. I believe paying down debt is one of the best investments anyone can make. After all, if you are like most people you pay 18.5 percent or even more on your outstanding charge card balance so if you use your tax refund to pay down your charge card debt you’re guaranteeing yourself at least an 18.5 percent return on your money. I don’t know any investment that can guarantee you that type of return.
For those of you who are not in debt, another good use of your tax refund is to establish an emergency fund. I’ve always been a believer that everyone needs a three to six month emergency fund. Establishing or replenishing your emergency fund would be a great use for your tax refund.
If debt is not a problem and you’ve already established your emergency fund, consider investing your tax refund. For those of you who are eligible for Roth IRAs, it is a great way to save for your retirement. Investing your tax refund and letting that money grow will pay dividends into the future.
Unfortunately, too many Americans will look at a tax refund as a bonus and a way to spoil themselves. Although I do believe it is important to occasionally reward ourselves and buy something frivolous, keep in mind when you use your tax refund to pay down debt, set up an emergency fund or to invest, you are rewarding yourself. Personal finances are something that keep people up at night and cause all sorts of problems within a family. Obviously, money and resources don’t guarantee family harmony. However, I can assure you that when your family finances are in order and when you’re not worried about what debt collector is going to contact you, it does make life a little easier. Therefore, my recommendation to you is that if you are going to receive a tax refund, be productive with it. Use it to improve the quality of your life and trust me, paying down debt and eventually becoming debt free will improve the quality of your life.
Good luck!
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com.