A tax refund is not a windfall

More than three out of every four American taxpayers receive a tax refund every year, and last year the average refund was $2,763, according to the IRS. So if like many Americans you filed your taxes near this year’s April 17 deadline, odds are you are waiting for a check to arrive.

If you feel like it’s a big midyear bonus, you need to amend your thinking. Receiving a tax refund in 2018 simply means that you gave the U.S. government an interest-free loan during 2017. That’s right, you let the government use money, at no charge, that you could have invested or used to pay off debt. The refund amount is simply money that you earned working in the previous year, not a windfall gift from the IRS.

If you got a refund this year, it simply means you overpaid your taxes last year, whether through payroll deduction or estimated quarterly payments. So one step you need to take right away is to correct this situation for the 2018 tax year. Adjust your 2018 tax payments downward so the total is more likely to match the amount due. Start by making sure you are taking all the deductions to which you are entitled.

That leaves the question of what to do with your refund amount, especially if it’s a significant amount of money. You can think of the funds as money that you saved last year without benefiting from interest payments.

You may choose to spend it on a summer vacation, or buy a new computer. But before you make that decision, think about it this way: What would you do with that money had you actually put it aside every payday in a bank savings account last year?

Well, if you believe you would have saved the money up for a vacation or computer, go ahead and enjoy it, nothing wrong with that. But if you’re trying to pay down debt, save for a home, or put aside money for retirement, these goals may take priority. If you made adequate progress toward these goals during the year, then you may prioritize a vacation trip. But if you didn’t make the progress you should have, it’s prudent to consider using your refund money to work toward those goals.

It all goes back to setting priorities in your financial planning based on your individual goals. If you are keeping good budget records, you can look back over 2017 and decide whether you reached your goals or not. Look and see how much you put aside for retirement. Do you have an emergency fund with six months’ worth of living expenses in cash? Did you pay debt down to the extent you planned?

If you already met or exceeded all of your financial goals for 2017, relax, take your refund money and buy a good steak while on vacation! If not, your priorities probably should relate to paying off debt and/or saving your money. Hey, you can still go out for a nice dinner down the street — just don’t spend it all in one place!