The Right Thing To Do With That Tax Refund (And Why You Really Shouldn't Want One)
Hi, my friend.
This isn’t exactly breaking news, but…. tax refunds are a really big deal.
According to the IRS, the average refund given out for this year’s federal tax filings through March 14 is $3,271 — up more than $150 from last year at this time.
That’s a big, big number, especially when you consider how tight most people’s budgets are today. An extra $3,000 can be a game changer, no doubt about it.
But what do you do with it?
If you’re like me and like most Americans, you owe at least a little bit on your credit cards, wish your emergency savings was bigger, have some long-term goals that you’re working towards and still want to mix in some fun every once in a while. That means that it isn’t always crystal clear exactly what you should do when you get a windfall like a $3,271 tax refund.
As with most anything related to money, there’s no one-size-fits-all right answer about what to do in this case. It depends on how much and what types of debt you have, how much you have in your emergency savings, how secure you feel in your job, what your main financial goals for the short, medium and long-term are as well as countless other factors.
That said, here’s what I’d suggest for most people…
Most of the refund goes to paying down high-interest debt
The next biggest chunk goes to building an emergency fund
If possible, another portion can go to your biggest long-term financial goal
And a small part of it goes to treating yourself.
That last part may be surprising, but I feel strongly about it. Sometimes you just have to give yourself a break and do something nice for yourself, even if that money could be better used for other purposes. For some people, that might look like a family dinner at Olive Garden, while for others, it might be a vacation or some other splurge. As long as the treat isn’t done too extravagantly or too often, there’s nothing wrong with it. After all, when your life is consumed with paying down debt, even just a moment away can help boost your energy to continue the battle.
The two most important things
Those first two bullets are crucial, however. Using this windfall to pay down credit card debt and other high-interest debt can be life-changing. I remember back in my 20s when I finally paid off my $10,000 in card debt, it felt like a boulder had been lifted off my chest. It felt like getting a raise at work. I’ll never forget it.
Still, building your emergency fund — even while you’re paying down your debts — is crucial. Yes, it may mean putting less toward your debt each month. Yes, that means that it may take a little longer and cost a little more in interest to finally pay off that balance. But yes, it is still the right thing to do.
Why?
Because if you have no emergency savings, the next big unexpected expense has to go on your credit card and you find yourself right back in credit card debt. However, if you have even a little bit of savings, you can use it to pay for that car repair or a surprise visit to the veterinarian. That is one key way to stop the cycle of debt that so many people find themselves in.
Of course, the above bullets are just a basic framework, a general suggestion of how to divvy up that refund. The details are up to you. If you get $100 back, it won’t be worth dividing the money up that way. If you get $5,000 back, you may want to divide it even more finely. What matters is making a plan that fits with your goals and your priorities.
Ultimately, you don’t really want a refund
Don’t want a $3,271 check from the government? Why on Earth wouldn’t I?
I hear ya. These windfalls can feel amazing, but here’s the thing…. That refund money has been yours all along. It was essentially an interest-free loan to the federal government.
It is money that you overpaid in taxes over the course of the year. It is money that could have been sitting in a high-yield savings account earning 4% instead of being held by Uncle Sam. It is money that could’ve helped extend your monthly budget just a bit.
I do understand the psychology in wanting a refund. Many people feel they’re more likely to put that money to good use when it comes in one big chunk as a refund than they would if it came in the form of a few extra dollars each paycheck. If that’s you, that’s fine. However, if you get refunds because you didn’t think you had any choice, that’s a different issue.
For many, all that will be required is contacting your employer’s HR department and adjusting the withholdings on your W4 form. (You can use this withholding estimator from the IRS to get a better feel for what to do.) For others, it may make sense to contact a tax professional to make sure you’re taking all of the deductions you should take and to ask any questions you might have.
The ideal goal? Getting your refund down to $0. You don’t want to overpay, give the government an interest-free loan and then get a big check, but you also don’t want to underpay and end up writing the government a big check either. However, the truth is that getting to $0 isn’t easy. The more realistic goal is to bring that refund number down as much as you can to keep more money in your pocket, but not so much that you end up owing.
Share your success story
Ask, Save, Earn — and my book “Ask Questions, Save Money, Make More: How To Take Control Of Your Financial Life” — is all about helping people pay less, earn more and keep more of their hard-earned money by asking the right questions and advocating for themselves in everyday situations. Got a victory you’d like to share? Drop it in the comments below or message me in the Substack app. I’d love to hear it.
Thanks!
Matt