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How Should You Spend Your Tax Return?

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Tax Extension

We got the call the other day. That call was from our CPA who had just finished preparing our taxes for the 2012 year. Our tax return for the year is a whopping $40 from the feds and $170 from our state. I know, don’t spend it all in one place, right?!  We’ll likely just put said money into our brokerage account at Optionshouse.

That said, there is regular debate in the finance community in regards to what you should aim for in terms of your tax return. You can adjust the size of your tax return with calculators. Some prefer to get a large tax refund and use the money on a variety of things, while others prefer to have the money throughout the year as a way to use it on things month to month.

With the anemic interest rate, the interest free loan argument is out the window. Still, I would rather have the money throughout the year as we’re disciplined with how we spend. If you’re counting on getting a tax return this year there are certainly many ways it could be spent and this is not meant to be exhaustive in nature. Before I go any further, I would like to emphasize that I am not a tax professional and that if you do have specific questions about your tax situation please seek out a tax advisor.

Don’t View Your Big Tax Return as a Temptation to Spend

 

The average tax return in 2011 was just shy of $3,000 and I don’t know about you, but that is a nice little chunk of change. Personally, I would adjust my withholdings to get more of that money during the year, but do what’s right for your situation. Getting that amount of money can give way to temptation if you do not watch what you’re doing.

Having a little fun is one thing, throwing it away on an 80 inch big screen TV is another. One of the things I would do when I used to get a large tax return was look at my financial situation as a whole and find where it would be best suited. I would often let the money sit there for a few days or even a few weeks until I determined what would be the best use of the funds. The point is that you do not always get a nice influx of cash like that, so act wisely and don’t spend it on something you’ll regret.

Paying Down Debt is a Great Way to Leverage Your Tax Refund

 

As I’ve shared in the past, I racked up nearly $25,000 in credit card debt while in college. It was largely due to stupid decisions on my part and buying stuff that I did not need. It took me nearly five years of hard work to pay off those credit cards and is part of the reason why I’ll never go back to that again.

One of the main ways I got my credit card debt paid off was by throwing the large majority of my tax return each year at my credit card debt. That allowed me to throw money directly at the principal of the debt which sped up the repayment as a whole. I also used this strategy as we paid off my student loans. Basically, any non mortgage debt we had, I would throw what I could of the tax return at it in order to free myself of debt quicker. This made it feel like there was actual light at the end of the tunnel and made the battle seem a little more surmountable.

Invest or Save the Money

 

Just like with throwing a large tax return at debt, it can also be used to help supplement a saving or investing strategy. Working in the financial services industry in the past, it was always popular to see people use their income tax refund as a way to fund their online brokerage accounts.

This can be a great way to get the ball started on putting money away for the year or take advantage of stock purchases you’ve had your eyes on. If that is not an option, then you can also look at putting the tax return money in an Emergency Fund. We personally started doing more of this after getting rid of our non-mortgage debt and it can be a very easy way to start building up your Emergency Fund.

Buy Yourself Something Fun

 

Let’s imagine that we’re all free of debt and that our tax return is found money; what would you do with it? One of our favorite ways to use tax refunds in the past was by going on a vacation as we’d use the funds to book a nice hotel room, or something like that. Of course, I would only endorse this if you’re out of debt and are disciplined with your money. That said, we funded the cruise we went on for our fifth anniversary largely from money from past income tax refunds and would do it again if we ever went back to getting a lot of money at year end.

If you do choose to use the money for something fun, enjoy it and do not feel guilty. Life is meant to be lived and enjoyed while having fun experiences. If you work hard and are debt free then doing something fun with the money is just fine. I mean, it is your money after all, right?

 

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Did you get a large tax return this year? Will you be doing something fun with any of it?

 

Photo courtesy of: 401(k) 2013

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I'm the founder of Frugal Rules, a Dad, husband and veteran of the financial services industry. I'm passionate about helping people learn from my mistakes so that they can enjoy the freedom that comes from living frugally. I'm also a freelance writer, and regularly contribute to GoBankingRates, Investopedia, Lending Tree and more. If you're wanting to learn how to monetize your blog, check out my blog coaching services to see how I can help you take your site to the next level.

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77 Comments

  • Margaret Polino Nicholas says:

    I also want to focus on credit card pay down.

  • We’re doing our taxes on Friday and I would be happy just to get ANYTHING back. If it was something sizable, like a few thousand, I would put it right into savings and perhaps use it as part of a down payment for a car that we will need sometime in the next year.

    • John says:

      I felt the same way DC, I was concerned that we would owe this year, but thankfully that feeling was wrong. I think if we would’ve gotten a large refund it would have gone towards saving/investing as well.

  • I received a decent sized refund this year. I try to limit it, but there were some new tax situations in play this past year and I was happier with over-paying because I feared a huge tax bill come tax time. When I do get a large refund like this year, I closely follow what you said: if I have debt, a portion of the refund goes towards that, a portion goes towards long-term savings, and a small amount is mine to do whatever I please with it. I’ve found that by letting me indulge a little, it stops me from going overboard.

    • John says:

      That’s cool Jon! I was afraid that we would owe this year, but thankfully approximated it just right. We like to divide ours up as well if we do get a larger refund so we can attack multiple things at once.

  • We got almost $2,300 back, way more than I’d like, but with getting married and just starting out in the dividend growth strategy I let the amount creep up to cover any unforeseen changes. The plan is to get it back down to around $1k. Our refund was already spoken for with my wife recently getting work done on her car and we had already earmarked the return to cover that. All preventative maintenance that should keep it humming for several more years. I’ll be taking what’s left over and adding it to the investment account. She doesn’t find that fun, but I do!

    • John says:

      That’s a nice sized refund! Glad you were able to work it out to cover some work on your wife’s car. Putting the rest into your investment account IS fun, but then again I am a geek like that. 🙂

  • Great ideas, John! Adjusting withholdings sounds like a good way to go.

  • jefferson says:

    our tax return this year was spent trying to get our house ready to sell (new driveway, tile in the bathroom, small repairs)… so in effect, it was an investment..

    • John says:

      I would agree, especially if it gets you to be able to get a better price. We’re redoing our bathroom starting in two weeks….sadly no tax return to help us with that. 😉

  • My tax returns are going straight into my investment account.

  • That was great planning on your taxes. I bet buying the iPad was what got you the refund!, or was that this year? I can’t really remember getting a refund, but I think when we did, it applied to next quarters estimates. If I actually got cash in hand right now, I’d probably use it for some landscaping projects we’ve been putting off.

    • John says:

      Thanks, all credit goes to our CPA. I was so afraid we were going to have to owe big time and thankfully I was wrong. The iPad was this year, so maybe it’ll work out towards that end for the next tax year.

  • Carrie Smith says:

    I didn’t get a tax refund this year — actually it’s been quite a few years since I’ve gotten one. But I agree with your points about leveraging it the best way possible. When I used to get a small refund (back in the day) I would put it towards debt, and then into savings. Of course buying yourself a little something is always fun too. Smart thinking John!

    • John says:

      I was concerned that we’d not get one this year either but thankfully just got by. Leveraging, in my opinion, is a great way to go because it allows you to attack several things at once. Thanks for stopping by Carrie!

  • I got a few dollars more than you back but I put every penny towards my debt 😉

  • I was going to save ours, but then we had to buy a couch, so I bought the couch on my Amex card, then used the refund to pay it off. I am working on getting closer to $0 for my tax returns, but having a baby gave us a nice refund.

  • Better the $210 be in your pocket than the taxman’s though. Tax rebates always seem to come at a time when I could use the extra cash. That’s the problem with being married with 2 kids, there’s always something boring to spend the money on!

  • I still don’t know yet if I’ll get a refund this year, but in years past as a freelancer, the first part would go to first quarter estimated taxes, then to pay my tax person, then some would go into my tax account for the following estimated taxes, and if there was anything left over it would go to savings. Boooooring! 🙂

    • John says:

      We’ve been right there Tonya, so I know how you feel. Thankfully we’ve been able to move our budget ahead to where we do not have to put it towards the next estimated tax.

  • Michelle says:

    We’re getting a large return and it’s ALL going towards student loans. WOOOOHOO

  • I actually have more discipline not spending a large amount of money than a small amount of money. If my paycheck increases by $10, then that’s a week of coffee. If my return is $500, then that’s a big chunk of change that I need to weigh my options and make an informed decision about how to use. And then I’m going to squeeze every penny out of that large purchase. We used our ~$1200 total return to buy a “new-to-us” washer and dryer and next a replacement computer before this one finally gives out.

  • Doing my taxes this weekend and hoping to see a decent return because NYS/NYC takes a decent chunk of my measly paycheck. What are your thoughts about receiving a tax return vs. owing the IRS and using the money to invest throughout the year?

    • John says:

      Hope you end up getting a return. Our state can be greedy in their own right in terms of taxes. I was surprised to get back what we did from them.

      In regards to your question (which is a good one btw), I know that there are some out there who do this. I personally do not because I would not want that feeling of owing over our heads and thus try to get it as close to $0 as possible. If you can make it work, then that’s great…you just have to make sure you do what’s right for your situation and make sure you don’t put yourself in a situation where they penalize you for owing too much.

  • Our tax return is going towards landscaping our yard for our new house! Next year if we get one it will be applied as a principal payment to our mortgage.

  • I haven’t receive a refund for a long long time. This year we owe about $600. That’s not bad actually. Usually it’s well into the 4 figures.

  • I had a sweet refund only thanks to property taxes and mortgage interest. I used it to buy my new laptop (necessary to work), and I saved the remaining amount.

  • pauline says:

    It is great to pay off debt with a tax refund, too bad you lent money to the state for a year instead of paying debt on the spot. Congrats on getting such a small refund. For the first year I am getting a big one and really annoyed because I just paid for Q1 enough to cover my all year worth of taxes and will still have to pay Q2 and Q3 before getting a refund at Q4..

    • John says:

      We ran into that possibility last year and just skipped paying for Q2 & Q3. I did not think we could do it, but our CPA said it was just fine.

  • Good ideas. Depending on how much I get back, nothing this year unfortunately, is how I decide what to do. If a decent amount, I may set a small portion aside to treat us to a nice evening out. The remaining amount I pay most toward debt and save a little. If I only get a small amount back I add it to the emergency fund if not currently at the level I would like it. If it is, then it all goes to debt. If you get a lot back you may want to consider increasing your exemptions some so you get the money throughout the year. I have done this in the past and taken some of that extra money and deposited it to my 401k.

  • Mrs. 1500 says:

    Doh, my return was 9K, waaaaaaaaaaay too much. Time to adjust my deductions.

    It went straight to the bank as my emergency fund was severely lacking. In the future, I’ll probably throw it at Lending Club or Prosper.

  • Great ideas, we use our tax refunds to pay down our mortgage debt. Obviously we try to ensure that we don’t leave any money left on the table for the tax man.

  • All of our stuff is with our accountant, but I haven’t heard the final estimate. I believe we will get a refund. I don’t like getting huge refunds but I also don’t like paying the tax man more come April 15. Fussy, I know! Great tips! If someone has non-mortgage debt, I also suggest using refunds to lower debt and bolster their emergency funds. I also encourage them (if their financial situation is not dire) to set a small amount, maybe a $100, to go towards family fun. It may not seem like much money, but with some creative thinking, you can still have a great time and prove to yourself and your kids that fun doesn’t always equal expensive.

    • John says:

      I hear you Shannon, I like to hit that spot too where you’re not getting much back but also not owing. I would totally agree that if you have non-mortgage debt then you should be throwing anything you get at it plus beefing up that E-Fund. Great point on using some of it on something fun we often do that ourselves.

  • We used our tax return ($10,000) to bring us up to our maximum contribution for our Roth IRAs for the year. I wouldn’t have even considered doing anything else with the money!

  • We got a substantial (over the median) refund this year- mostly because I forgot to adjust withholdings once C stopped receiving UE (which we weren’t paying taxes on), and also because we were able to claim a credit that we normally can’t.
    In our case, the refund came in right at the time that our final bill to our adoption agency came in, and was just a few hundred more than that bill, so that’s what we used it for, enabling us to not pull money out of savings for it.
    This next year, I expect we will owe a considerable amount in taxes, so in the end, I guess it will even out.

    • John says:

      That’s awesome it came in time to pay the final bill on your adoption! I can’t think of anything better than that and it’s great the timing was perfect. 🙂 Congrats on the adoption! 🙂

  • I just got my taxes back and I’m trying to figure out what I should do with them, possible debt repayment or save them. So many choices !

  • We got a fairly small return this year and we put it into our vacation fund!

  • I won’t get a sizable return, but the money would definitely go into a Roth. We are young and have a long way to go with our portfolio!

    Love your articles!
    Jacob

  • Mackenzie says:

    We still have to do our taxes, unfortunately 🙁 I hope we get something back! More $$ towards the EF!

  • Jose says:

    100% of our tax return, state and federal, is planned towards going to debt reduction. Should my employment prospects fail in the next few weeks then those plans will change, but for right now that’s how they are earmarked.

    • John says:

      That sounds like a great plan to me Jose! Good luck on the job front, did you hear anything back on the possibility you mentioned last week?

  • It’s amazing that the average refund is about $3,000! People should learn to adjust their withholding to pocket more of that money throughout the year. If you’re able to save most/all of the refund money, then it can be a great way to ‘force’ yourself to save throughout the year – similar to the concept of a 401k or other automatic savings contribution that comes out of your paycheck off the top. Try the following prioritization (similar to what you suggested above): (1) pay down debt, (2) save some money, and (3) enjoy and spend a little!

    • John says:

      I completely agree Kirby! It makes no sense to me, but then again different strokes for different strokes I guess. I would agree that is a great prioritization to have with a decent sized refund. Thanks for stopping by!

  • I’m with you John…I would prefer to have the money throughout the year instead of one big refund check. I won’t know for some time about our situation as my accountant wife has already filed an extension for our personal returns. She has too many other returns to worry about at work right now! Maybe whatever we get back this year I’ll use to throw a big party for my wife when she gets her CPA license this summer.

    • John says:

      Yep, that’s the way I like it. I can totally understand why you would not know for some time and I think that idea of a party is a great idea!

  • Justin says:

    Our tax return was relatively high. This is mainly due to my schooling. We’re going to use the money to pay down our debt, so I suppose it’s not a bad thing.
    With new sources of income this year, we’re going to continue to claim the same numbers so that we can have a little room in case we owe more money because of the side income.

    • John says:

      That sounds like a great plan Justin! Having that side income can make it a little trickier and we have found that it really is a moving target to hit.

  • I got a giant tax return this year due to my tuition tax credits and I put it all towards my student loans. I definitely love getting a big tax return and putting it towards debt, it’s such a boost and really renews my enthusiasm to keep at my debt pay off strategy.

  • You know what? Every now and then you gotta go crazy, i say you forget the usual stuff and treat yourself to a Ford Mustang! (Yes I am a bad influence)

    • John says:

      Lol! Why stop at the Mustang when you can get something like a Ferrari?! 😉 Seriously though, I agree you need to spend some of it on something fun.

  • Agreed, I think it should be saved or invested.

  • I’m not getting much of a tax return but what I do get is going right back into my investments. I know some people run out and blow the lot which in my opinion makes no sense if they have debt they can put that on. It’s not found money. Cheers

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