How to spend your tax refund
3 in 4 Americans will get or have already gotten a refund this year. The IRS is reporting the average refund is about $3,100. Many of us have that money earmarked for specific things before it ever hits our bank accounts. This year, Barry wants to challenge people to rethink their refund and look for ways to use it to further their financial goals.
People can use their refund to achieve their financial goals in a few ways. The first is to find a purpose. Think about how you’re using your tax refund. Are you spending it on temporary things? A recent survey found 15% of people planned on spending their tax refund on essentials like gas and groceries. If this is truly where your need is the greatest, please use your refund on those essentials. If these needs are met, find a purpose for your money. How can you spend your refund that you will remember later? Small expenses on temporary things like dinners out, trendy clothing or the latest health fad will likely be forgotten 20 to 30 years down the road. Consider spending your refund on things that add value to your life.
Another use would be to eliminate debt. One of the most beneficial things you can do during your working years is eliminate your debt. Compounding interest works against us when we’re dealing with debt. As high-interest debt compounds on a monthly, weekly or daily basis, depending on the repayment agreement, your balance increases along with the amount of time it will take you to pay it back. Also, consider the returns on your investments. If your returns on investments aren’t equal to or higher than the interest rate on your debt, you’re losing money and need to take care of your debt ASAP. The arrival of your tax refund might be the perfect time to make a larger payment on your debt to decrease the principal amount or eliminate the debt altogether.
Finally, look for ways to put your money to work for you! Use your refund to save for your future. Unlike the negative impact compounding interest has on debt, compounding interest can significantly grow your investments. The sooner you get started, the longer the investment has to grow. Consider opening a Roth IRA or an after-tax account. You will need to pay taxes up front, but the money contributed to these types of accounts grow and are withdrawn tax-free in retirement.
Many people view their tax refund as a windfall or free money! However, the money you receive back from the IRS was money you earned the year prior. You’ve simply given it to the IRS to hold onto without accruing interest, and you are now getting back in the form of a refund. I hate to break it to you, but that money doesn’t hold the same purchasing power as when you gave it to the IRS. Think about the rapid increase of inflation in the last year; $100 doesn’t go as far as it did a year ago. If you get a large refund year after year, consider increasing your withholding. This will put more money in your paycheck now and decrease the amount you get in a refund. If you’re always paying come tax day, decrease your withholding. You will see your paycheck decrease slightly, but over the long term your tax bill should decrease since you’re giving the IRS more money throughout the year. Review your W4 form and, if necessary, adjust your withholding through your employer and consult with a CPA if you have any questions.