A road map to letting refund work for you
Many Americans are expecting to receive a windfall from filing
If you’re eagerly anticipating a tax refund in the coming weeks, you have good reason to be optimistic: The IRS reports that 77 percent of tax returns filed last year generated a refund, and the average refund was $2,815.
Even though what can feel like a gift from the government is actually a delayed receipt of your own money, the best use of those funds is not always apparent. This year the question is even more fraught, with many households facing increasing financial pressure from inflation, rising interest rates and expiring government assistance programs tied to the pandemic. Advance child tax credits, for example, which offered families monthly checks based on their income and number of dependents, have ended pending further congressional action.
“For many people, the advance child tax credits became a part of their budget, so you should consider saving your tax refund and using it to supplement your monthly budget going forward,” said Tommy Blackburn, a certified financial planner in Newport News, Va. “That can help with monthly cash flow.”
Another option is to adjust your withholding to every paycheck so you don’t pay more tax than you need to. But, Blackburn said, some people prefer to receive a lump sum each year as a method of forced savings.
While your refund priorities depend on your particular situation, there’s room in almost every budget to spend at least some portion of your refund check on something fun, too. Here is a road map to help you decide what you should do with the money:
Save for next emergency
“First, think about your nearterm security,” said Vince Shorb, CEO of the Las Vegas-based National Financial Educators Council, which supports financial wellness educators. “There are a lot of things going on, from COVID to inflation. I want to make sure people have food on the table and gas to get to work,” in the event of an emergency like job loss or unexpected expense, he says. That means putting money into an emergency savings fund before any other priority, including paying off debt.
“With inflation, you want to save a little bit more than normal to plan for those crazy gas and food prices. We don’t know what will happen next,” said Scott Alan Turner, a CFP in Aledo, Texas. While financial experts often cite the goal of having three to six months of expenses tucked away, a more realistic goal can be saving $500 to $1,000, or at least half of your refund. Given rising prices, it’s better to save more if you can.
Unload high-interest debt
With interest rates widely expected to rise this year, credit card and other variable-rate debt would likely become more expensive, which makes using refund money to pay it off a smart move, said Mike Biggica, a CFP in San Francisco. Pay off any debt that carries an interest rate of 6 percent or higher and also focusing on student loans, medical debt and anything else that carries a variable rate.
Maggie Klokkenga, a financial coach and CFP in Morton, Illinois, suggests using an online debt calculator to see how making extra debt payments can speed up the debt payoff process. That can help you decide whether to first pay off your smallest debts or larger, highinterest ones.
Make room for other goals
If you already have your emergency fund and high-interest rate debt addressed, then Klokkenga suggests putting the refund cash in high-yield online savings accounts. “When it’s not in your checking account, it’s harder to get to and gives you a pause before you can get the money,” she said.
Increasing your contributions to existing retirement accounts such as a 401(k) is another solid option, Biggica said. “For folks who are not already maxing out their 401(k), that increase in contribution makes them feel more secure and responsible.”
In some cases, you can frontload your contributions, which means you reach the annual contribution limit before the end of the year. Your take-home pay will be higher by November or December, which offers flexibility to pay for end-of-year costs like holiday spending.
Splurge within limits
After taking care of emergency savings and debt payments, Turner suggests squeezing in something enjoyable.
“Go out and celebrate with something frivolous and entertaining: a nice steak dinner, new designer jeans, concert tickets.”