How Should You Spend Your Tax Return?
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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?
Additional resource: If you’re looking for a simple way to stay on top of all your finances, then check out my favorite new tool – Personal Capital. Completely free, it allows you to track your spending, monitor your bank and investment accounts and watch your net worth plus many other tools.
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
John is the founder of Frugal Rules, a dad, husband and veteran of the financial services industry whose writing has been featured in Forbes, CNBC, Yahoo Finance and more.
Passionate about helping people learn from his mistakes, John shares financial tools and tips to help you enjoy the freedom that comes from living frugally. One of his favorite tools is Personal Capital , which he used to plan for retirement and keep track of his finances in less than 15 minutes each month.
Another one of John's passions is helping people save $80 per month by axing their expensive cable subscriptions and replacing them with more affordable ones, like Hulu with Live TV.