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Sensible Strategies for Your Tax Refund

I wrote a few years ago about five smart ways to use your tax refund: 1) maxing out an IRA, 2) boosting emergency savings, 3) paying down debt, 4) investing the funds, or 5) putting it into a business. While these are all great ideas, and I still think they are the smartest things you can do with a refund, I also realize it’s not always so easy to take “found money” and devote it all to something so sensible.

So, go ahead, live a little. But here are a few strategies for doing so sensibly.

1. Think about “spending to save.” Maybe you could invest in energy-efficient windows for your house, something that will save money down the line or increase the value of your house. Other purchases, such as a hot tub, would really not save money or provide any sort of payback when you go to sell your house.

2. Use it to avoid credit card debt. A lot of people use tax refunds as a way to pay for vacation, summer camp for their kids, or other special purchases. If using your tax refund means that you don’t have to put a significant charge on a credit card, that’s all the better.

3. Spend some, save some. A sensible, “live-a-little” strategy might mean that you don’t sink the entire refund into the cool vacation but also put a little bit towards something for your future, like your retirement or a 529 plan. Maybe two-thirds will go to something fun and one-third gets saved, or maybe it’s 50/50. Whatever you save, it should be a substantial portion of it, something that is beyond what you might otherwise save out of your daily budget.

4. Resolve to have less withheld from your paycheck. Think about how you can change your withholding and savings strategies so that the government takes out less from each paycheck while you increase the amount you save each month, whether through direct deposit to a regular savings account or a 401(k) retirement plan of a 529 college savings plan.

5. Don’t think of your tax refund as “free money” from Uncle Sam. A good argument can be made that you should never be getting a tax refund, because it’s nothing more than an interest-free loan to the government. I try never to get back more than $200 from the government; one year my refund was $12! I realize that a federal withholding can be an effective form of forced savings for many people, but I think, with a little planning, that money can be put to work far more effectively.

6. Don’t get a cash advance on your refund unless it is an emergency. I see TV ads that suggest taking an advance on your income tax refund. This does enable you to get the money faster for real emergencies, such as fixing the roof or an automobile, but at a cost. This is why it is important to develop an emergency savings fund, so that you don’t have to borrow money at exorbitant rates to deal with the inevitable bumps and bruises of life. If you find yourself getting an advance on this year’s refund, see if you can’t make some adjustments to your withholding so that the money is already in your savings account next year, because you didn’t overpay the government.

7. Don’t let the government keep it. Finally, the one thing I never do is let the government keep my refund as a payment towards next year’s taxes. Even if I am making quarterly estimated tax payments, I still want that refund back to me, because I think it’s too easy to lose track of the refund. I don’t want to end up arguing with the government over whether they have my money or not.

So, go ahead, have some fun with your tax refund, but also try to balance the short-term joy of spending it with the long-term payoff of investing it wisely. Your future self will thank you for being so far-sighted.

This post is for informational purposes only and should not be considered as specific financial, legal or tax advice. Depending on your individual circumstances, the strategies discussed in this post may not be appropriate for your client’s situation. All opinions expressed in this post are solely those of the author and do not necessarily reflect the opinions of Penn Mutual, its affiliates or employees. The information in this material is not intended as tax or legal advice. Always consult your legal or tax professionals for specific information regarding your individual situation.


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