How Should You ‘Spend’ Your Tax Refund

Are you getting a tax refund this year? Plenty of folks are. Much like trivia, running through the IRS data is always interesting…at least for those who love diving into the minutiae. So here are some tax facts for the 2022 season:

• Through March 25, 2022, the IRS has received over 81 million returns and processed just under 79 million returns.
• Roughly half the returns were delivered by tax professionals and the remainder were self-prepared.
• So far, the IRS has sent out almost 58 million refunds checks totaling $188.7 billion. The average tax refund is $3,263, which is 12.4% above a year ago. It’s a pretty good chunk of change for the average person.

While I generally counsel against an interest-free loan to the federal government, some folks like what might be called “forced savings.”

But, getting back to our title, how might you best “spend” your lump sum. Maybe a better question we can ask is how might you best “invest” your cash windfall?

Not everyone will receive a refund or a large check from the IRS. But ideas I’ll put forth can be used when receiving any gift, bonus, or unexpected cash windfall.

Before we dive in, I want to quickly add: If your children, a relative or close friend has talked about their refund, feel free to forward these suggestions to them.

7 smart ways to invest your tax refund

1. Do you have a rainy-day fund? Is if fully funded? You understand the importance of reserves. Whether it’s a home repair, auto repair, a layoff or unexpected bill, having cash set aside will ease the financial burden.

I recommend three to six months of readily accessible savings in the event of an emergency. If you don’t have a rainy-day fund, don’t procrastinate; get started today. 

2. Get out of debt. Years ago, I saw a quote that went something like this. “The road to poverty is paved by high interest rates.” I don’t know who coined the phrase, but too many people run up high-rate debts and struggle to pay them off. 

Pay down or pay off high-rate credit cards or unsecured loans. You might start off with the card with the lowest balance first. Wiping the slate clean on a card or cards is a big psychological win and will encourage you to stay in the battle until you are out of debt.
 
3. Tackle your student loans. Can the president simply wave his hand and forgive your student loans? If he could (and maybe he can; the jury’s still out on this one), would you receive a 1099 for debt that’s forgiven (the devil is always in the details)? Or, for that matter, should you wait for the bureaucracy to solve your problem? 

If you have an emergency fund and credit card debts are low, consider tackling your student loans. Sure, they helped you get through college, but they are a burden hanging over your financial future.
 
4. We reap what we sow. If you don’t sow into a retirement plan, there will be no harvest come retirement. For example, if you take the hypothetical $3,263 tax refund and stash it in a Roth IRA, you’ll have $32,834 in 30 years, assuming an 8% annual return. Plus, you’ll pay no federal income tax when you take a qualified withdrawal from a Roth IRA. 

At 10%, you’ll have $56,937, and at 6%, you’ll have $18,741. Of course, returns aren’t guaranteed and may vary, but trading one’s natural inclination for instant gratification for a future payoff can pay you a handsome reward.

5. Invest in the future of your child, grandchild or yourself. There are various options, and we can point you in the right direction to help get your started. 

You might consider an education savings account of a 529 plan for your kids. While you won’t get a tax deduction for contributions into the accounts, these vehicles allow you to grow the nest egg tax-free, and they can be withdrawn for qualified expenses without a tax liability.
 
Have you decided that you would like to invest in yourself? Do you want to ascend to the next level? Certifications and college classes can help sharpen your skills. Even if you are not career-oriented, investing in your hobbies can bring added enjoyment.

6. Gifting your refund. You may decide that you don’t need the money. I know folks who gave away their stimulus checks to their kids or charity. What puts a smile on your face? That may be the appropriate strategy for your refund. 

7. Have some fun. As we said, the average refund check so far has been $3,263. You may take one of my ideas to heart and earmark the lion’s share toward that goal. But don’t be afraid to save some for yourself. 

Whether it’s a nearby weekend trip, a day trip to the spa, or that expensive restaurant you have always wanted to try, it’s OK to take care of yourself.

These suggestions are just food for thought. But be strategic. Think long-term. And take some time to consider what you might do with your refund or any windfall you may receive. A lack of planning and impulsive decisions can be costly. And remember, I’m always here to assist you.