The Best Way to Spend (or Not) Your Tax Refund

By FOXBusiness

Getting money back from Uncle Sam can be a nice windfall of unexpected money, but don’t let it burn a hole in your pocket.

Continue Reading Below

“When people get that refund they want to spend it because they feel like it’s free money even though it’s their money,” says Jeff Bucher, president of Citizen Advisory Group. “At the end of the day, it might make the most sense to apply it toward any high interest rate debt they’ve accumulated.”

Taxpayers need to keep in mind that a tax refund is essentially the government returning money they overpaid at some point over the last year. Experts recommend evaluating your financial situation to best determine how to use the refund: pay down debt, increase savings, spend it or use it to invest.

If you have credit card debt or other high interest rate debt, financial experts recommend using the money to pay it down.

If you don’t have any debt, review (or create) your rainy day fund to make sure it has enough to cover three to six months of expenses, suggests John McDonough, managing member of the general partner of Studemont Group.

If you have no debt and enough savings tucked away, financial advisors recommend spending a portion of the refund and investing the rest.

Opening up a Roth IRA with the tax refund can help establish more savings because you won’t get taxed on any investment gains, says Andrew Meadows from The Online 401(k).

“When you go on a diet you are rewarded with lower weight, and the same thing goes for the tax refund,” says Meadows. “Give yourself a little something but the rest of the money goes toward the future.”

Whether you spend or save your tax refund, it’s important to have a long-term view.  A $3,000 refund may not seem like a lot for one year, but if you get that same amount for 20 years, it can really add up. “People aren’t very purposeful about how they spend $3,000 a year, but over 30 years, it’s real money,” says David Richmond, founder of Richmond Brothers.

For many people, getting a big refund check each year is a nice surprise, but they should evaluate their withholdings because they may be losing out. Richmond says that if his clients get anything more than $2,000 or $3,000 back, he works with them to better estimate their taxes so less is taken out from each pay check.

“The government is holding the money all year,” he says. “It’s better to re-estimate your withholdings then give a free loan to Uncle Sam.” By having the money sit with the government instead of in your pay check, you are losing the ability to earn interest on it or use the extra money to reduce debt.

An easy way to calculate how much should be withheld is to go to the use the calculator on the IRS website. Once you figure out the appropriate number, call your human resources department to g et a new W4 form and have it adjusted based on what should be withheld.

“Some people like the concept of forced savings but they don’t understand that the government is using that money for 0% interest,” adds McDonough. “Ideally you should be getting zero back.”

What do you think?

Click the button below to comment on this article.