It's the question du jour. What should you do with your tax refund? I'm going to do my best to answer this question, hopefully with a smidgen of useful originality.
First, let's review. Everybody, and I mean everybody, has added their two cents. A quick search with the
Even a cursory review of these websites shows that they offer good, responsible advice. The tips include beefing up an emergency fund, paying off credit card debt, funding a retirement account, and saving for a child's education. Rarely do these articles suggest using a tax refund to buy a car you can't afford, to increase your cable package from 500 channels to 42,800,000, or to lock in an expensive, 2-year cell phone contract. I guess we have the rest of the year to do those things.
What's curious about these articles, at least to me, is that they are written at all (the irony that I'm writing such an article is not lost on me). Do people really need to turn to the now government-controlled Internet to figure out how to spend their refund? We don't search the Internet for advice on how to spend our paychecks (check that--the search 'How should I spend my paycheck' returned 1.31 million results, so I guess some people do need such advice). It's still surprising to me that this content is so prolific.
If you have read this far, you are either mildly amused or truly looking for advice. I'll assume the latter. Here are 7 things to do if you get a tax refund and are wondering what to do with it:
- Withhold less: If you get a refund, it means you paid more taxes during the year than you owed. The result is that you gave the government an interest free loan. Adjust your withholdings to reduce your refund to as close to $0 as possible. It's easy to do.
- Think small: If you are searching for ideas on how to use your refund, then you are suffering from lumpsumopathy (a made up word that didn't return any results in Google . . . until now). It's a condition that causes us to treat larger sums of money differently than we treat smaller sums. We carefully consider how to spend a $1,000 tax refund, but we give no thought on how to spend the extra $50 we may have at the end of each month. The result is that we spend the $50 mindlessly. Save and invest it instead, and in ten years you'd have $9,258.28 assuming an 8% return. The number jumps to $175,764.06 over 40 years.
- Be patient: There's no rule that says you have to use your refund as soon as it flows into your bank account. Let it sit in the bank for some time, preferably in a high yield account like one of these. Then spend the time necessary to make sure you have established the best financial priorities for you and your family.
- Go liquid: As you ponder what to do with your new found wealth, consider leaving it in the bank. In a Bankrate poll, only 39% of those surveyed had enough to cover at least three months of living expenses. You want to be part of the 39%.
- Hire a CFP: If you have your emergency fund in good order, hire a Certified Financial Planner to help you develop a financial plan. Understanding your financial options, establishing solid goals, and creating a plan to reach those goals could be the best way to spend your refund in the long term. Just be careful not to let the CFP sell you expensive life insurance, non-traded REITs, or investment advisory services that cost more than 30 basis points (the fee Vanguard charges).
- Invest long-term: If you've made it this far down the list and still have some money burning a hole in your pocket, invest it. Whether you fund an IRA, an HSA, increase your 401k contributions, are move it to a taxable account, put the money in low cost index funds according to your investment plan.
- Pay down debt: Finally, consider paying down debt if you still have money left over. It goes against the grain to put this option at the end of the list. Unless you have debt at extremely high interest rates, in which case you should be refinancing the debt anyway, investing for the long term is the better option for most in my opinion. Paying down debt monthly by developing a sound budget and sticking to it helps us develop financial discipline that simply throwing found money at the problem does not.
For better or worse, there's my contribution to the tax refund question. Now Google has 42,800,001 results to show the world.
