Each year, roughly 75% of taxpayers get a refund from the IRS because the amount withheld from their paychecks wound up exceeding their ultimate income tax liability. We’re not talking chump change here either: The average refund tends to be just under $3,000, according to the IRS.
That’s a lot of money for anyone, especially in the current economic climate where job security is pretty much nonexistent, student loan debt has surpassed the $1 trillion mark, and the average household owes about $6,980 to credit card companies. On top of all that, only two in five consumers actually adhere to a budget.
So, with most of us clearly in need of some extra cash, two questions are likely at the forefront of our minds as Tax Day nears: 1) Am I going to get a tax refund? and, if so, 2) How should I use it?
Am I Going to Get a Tax Refund?
Based solely on annual averages, the odds of receiving a tax refund are certainly in your favor. But don’t use that as an excuse to count your chickens before they’re hatched. While you can certainly get a sense of whether or not you’re in line for reimbursement by using a so-called tax calculator or doing some quick math to compare your withholdings to your year-end taxable income, you shouldn’t count on having that money when planning or making expenses before it’s actually in your bank account.
The good news is you don’t have long to wait. Even though the IRS started processing tax returns about 10 days later than usual this year because of Congressional uncertainty, it still expects to send refunds roughly three weeks after people submit their returns.
How Should I Use It?
Take a look at the results from the various tax refund surveys now circulating the Web, and you’ll see an overarching theme emerge: more than anything else, people intend to save their money this year. For example, 47% of those who expect to receive a refund plan to save it, according to a poll from TD Ameritrade, while 44% plan to pay off debt and 15% plan to invest. Those are very encouraging figures.
However, according to that same survey, 28% of people who expect a tax refund plan to purchase necessities, while 15% plan to put it toward discretionary expenses and 6% say they’re going to donate the money to charity. These results are slightly more worrisome, given the obvious trouble we’ve had distinguishing between luxuries and necessities in recent years. After all, nearly 10% of people see a flat-screen TV as a necessity, according to data from the Pew Charitable Trusts. What’s more, a recent poll conducted by the telephone service provider Cricket Wireless revealed that 17% of people consider having a tablet a necessity, while 48% feel the same way about cable and a DVR.
Ultimately, regardless of what we said when those pollsters called, interrupting our dinners in search of information on which to base survey results, it’s very important that we remember our recent economic struggles when it comes time to put refund money where our mouths are. Too many of us seem to think that we can just revert back to pre-recession spending habits now that the economy recovery has begun. The thing is, we couldn’t afford those spending habits even when they were buoyed by the housing bubble, so what makes us think now is any different? In reality, if we do not stem the rising tide of debt soon, we could be in for a double-dip recession.
It is through such a prism that you should view the following tips for strategic use of tax refund money:
- Strengthen Your Financial Safety Net: For many folks, the economic distress of the Great Recession was exacerbated by misplaced, or perhaps unhedged, optimism. We thought income levels could only go up, so there was no need to bother establishing financial reserves in an emergency fund. Of course, we then had nothing to live off during the extended periods of unemployment that characterized the downturn for so many. So, your top financial priority these days should be to gradually put away about a year’s after-tax income in case another break-the-glass situation comes about. Believe it or not, but establishing at least minimal financial reserves is more important than paying off existing balances given that even if you’re debt free, you’re only one major unexpected expense away from being back in the red if you don’t have an emergency fund.
- Pay Off Debt: No one wants to live with the increased costs and stress of unnecessary debt. The most strategic way to pay off amounts owed is to attribute minimum payments to all but the balance with the highest interest rate, which you’ll put the remainder of your allotted monthly debt payment toward. Once your most expensive debt is gone, repeat the process until you’re debt free. Credit card companies are currently offering 0% introductory interest rates for as long as 18 months, which means the right balance transfer credit card could become quite the asset in your pursuit of debt freedom.
- Invest: Whether it’s putting your money in an IRA to lower next year’s tax burden, adding to a 529 Savings Plan to help your child pay for college, or further diversifying your stock portfolio, there are plenty of sound investments to be made these days. Don’t ignore the benefit of investing in yourself through things like continuing education classes either.
- Refinance: Mortgage rates to continue to hover at historic lows, and your tax refund might enable you to afford the closing costs associated with a refinance. Just make sure to do your homework before pulling the trigger.
- Start a Business: Maybe you’ve been contemplating a career change. Or perhaps you simply want an alternative revenue stream. Well, your IRS refund could represent some helpful seed money.
- Avoid Prepaid Cards: This isn’t really a tip for how to use this year’s tax refund, but rather how to receive it. Many tax preparers and some states offer to disburse tax refunds via prepaid card, but prepaid cards often charge a variety of small fees that can eat away at your money over time if you’re not careful. If possible, direct deposit is the way to go.
Whether or not you agree with our advice, you don’t have to take our word for it. In the interest of representing various perspectives, we also asked professors of personal finance what they believe are the best ways to use tax refunds. Here’s what they had to say:
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