What Should You Do With your Tax Refund?

A tax refund can give you a sudden influx of unexpected cash that you can use for a variety of purposes. But make sure you have a plan for the money, and don’t be in too much of a hurry to get your money by signing up for a refund anticipation loan or other product. “Generally this is a bad idea,” says Ben Wacek, a certified financial planner and founder of Wacek Financial Planning, LLC. “It's important not to rely on a refund for financial well-being, and so it's best to just be patient and wait for the refund.”

 

Make a Plan

Don't wait until your refund hits your checking account to decide what to do with it. “The biggest mistake I see people making with their tax refund is waiting until it is received to decide how it should be used,” says Wacek. If you don't plan, he warns, you're more likely to spend it aimlessly. Conventional wisdom suggests you’re best off paying forward on long-term financial goals. But what would you do if you found money on the street, asks Jesse Bunse, a financial planner with Triune Financial Partners, LLC in Overland Park, Kansas? Would you sock it away for the future or would you put it In your wallet for daily spending? “There is nothing wrong with using the money for something like a new television or vacation as long as there are ample emergency funds, retirement accounts are being adequately funded and, most importantly, there is no consumer debt."

Catch Up on Financial Goals

Use your refund to get back on track with your financial goals if you've fallen behind during the year. “An unexpected tax refund can be a great opportunity to take care of important financial goals that have been neglected,” suggests Wacek. For example, you could use the money to contribute to a Roth IRA or to allow the money to grow tax-free for retirement. If you have a high-deductible health insurance plan, you can contribute it to a health savings account for a tax deduction and tax-free withdrawals as long as you spend the money on healthcare costs.

Invest It

Choose how to invest the money depending on how far out your goals are. The longer your horizon, the more risk you can take. “Shorter-term goals of three years or less should always be in safe, ideally FDIC-insured, investments such as CDs or even a good old-fashioned savings account," says Bunse. If your goals are farther in the future, you can shift more of your money to equities because you have time for the market to recover if it takes a downturn.

Don't Give It to the Taxman

Think twice before just rolling over the money to go toward your tax bill the following year. When you’re entitled to a refund, you have the option to apply it to the next year’s tax bill. However, neither Wacek nor Bunse have particularly favorable views on this option. “If someone is getting a refund one year, then they are likely to receive a refund the next year if there are no major changes,” says Wacek. Both Wacek and Bunse suggest reducing withholding for the next year to avoid such a large refund. Though, Bunse notes, “While this may not always make financial sense on the surface, applying the refund to the next year’s tax bill could be a good option for people who would be likely to spend the money when it may be able to be put to use for better purposes.”

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