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Four Smart and Nine Dumb Things To Do With Your Income Tax Refund

happy woman with raining moneyMost experts say that it’s not really a good idea to let the federal government keep a bunch of your money just so you can get it back in the form of a refund. We know it feels great to get a big check in the mail but what this basically amounts to is loaning your money to the government interest-free. One way to give yourself an immediate raise would be to stop over-withholding. Visit the IRS W-4 calculator to see if you should make an adjustment in your W-4 at work to have less money withheld. You wouldn’t get as much of a refund next year but you would have extra money every month that you could save or use to improve your life.

As you might guess, most Americans don’t do this. In fact, the average American will get a tax refund of about $2600 for the year 2013. If this is the size of the tax refund you either just received or will be getting, there are four smart things you could do with the money and, well, nine kinds of dumb things.

First, the smart things

1. Use the money to create an emergency fund. Experts say that you should have the equivalent of six months’ living expenses in an emergency fund. If this doesn’t seem doable you should have at least three months’ worth. That way, your bills will get paid on time even if you get sick, suffer an accident or lose your job. This means you will never have to pay late fees, need a cash advance or pay high interest on a credit card.

2. Save on insurance. You may not be aware of this but most car insurance companies will give you a nice discount if you pay your premiums for six or 12 months all at once. You could use a piece of your refund to do that and then put the rest into a savings account. When you have more money in your savings account, you could raise your deductibles – which is an easy way to save 10% to 20% on your premiums.

3. Start a business. A very smart way to use that refund would be as seed money to start a side business or take classes in a skill that you’ve always wanted to master. As an example of this, you could create a website and then sell your own arts and crafts. And if you increase your skills, this could provide the ammunition you would need to ask for a raise.

4. Save for college or retirement. Finally, you could begin funding a 529 college savings plan for your children or an IRA for your retirement. This both plants money you would harvest in the future but could also earn you a deduction on next year’s taxes. You can put as much as $5,500 in a traditional IRA and probably deduct it from your income. Or you could find a Roth IRA with after-tax money but then take it out tax-free when you reach age 55 ½ (or later).

frustrated looking womanNow, the not so smart

1. Spend it instead of investing it. We understand spending the money is a lot more fun than saving it. But consider this. If you were to invest a $3000 refund every year and got an annual return of 10%, you would have $189,000 in 20 years. This could mean retiring a couple of years earlier.

2. Not spending it on something that will reduce year’s taxes. If you just can’t handle the idea of saving the money, at least use it for a home improvement that will both increase your home’s value and create a tax credit. As an example of this, you could buy a solar water heater for $3000 to $5000. This would reduce your electric bill by about 20% for as long as you own the house. Plus, you would get a credit of about 30% of the cost on next year’s taxes. This means if you were to spend $4000 on that heater, your tax bill next year will be $1200 lower.

3. Spend it instead of paying down debt. Are you sure you don’t want to make your credit card company even richer? You can make yourself richer instead by paying off your debt. Today, if you invest your tax refund it’s very difficult to earn 10% but it’s a sure thing if you pay down a credit card that has a 15% interest rate. In fact, paying it off is the equivalent of earning 15% risk-free and tax-free.

4. Not creating a memory. If you put that refund into your checking account and then spend it a little at a time then when it’s over what do you have? Probably nothing much. If you’re convinced that you just need to spend that refund, at least spend it on something that will create a memory. Check out Costa Rico or go to Paris. In other words, do just about anything except letting the money drain away in drips and drabs

5. Loaning the money. Don’t let your friends and relatives know you have a nice refund coming. If so, don’t be surprised if they start hitting you up for a loan. Loaning money to friends and relatives is almost a certain way to turn them into enemies. Plus, you may never see the money again.

6. Not doing something to better yourself. Surely there’s something you could do with that money that would pay dividends at work. Maybe you could use it to take a class that would help you win a promotion or a raise. Or you could use the money to buy a computer and software that would help you make some money in your spare time.

7. Using it to make more debt. At the top of the list of dumb things to do with your refund is using it to make a down payment on a car or some other big purchase – especially an asset that will just lose value or depreciate over the years. Instead, pay cash for a good used car and then go on a cruise.

1040A form8. Taking it to the mall. When you get a check from the IRS you may feel as if you’ve won a jackpot. But this isn’t “found money.” It’s your own money. If you didn’t need a new suit or game controller before that refund arrived, you probably don’t need it now either.

9. Using it to fund an unsustainable lifestyle. One big sign that you’re over your head is if you get a high-interest refund loan or what’s called a refund anticipation check because you just gotta have the money immediately. Make a pledge to never again pay fees or interest to get faster access to your own money. Then go to work and try to do whatever you can to make whatever caused this craziness unnecessary.

Checking on your check

If after having read this article, you’re just chomping at the bit to get your refund, you can go to the page Where’s My Refund on the IRS website to check on its status. Or you can call 1-800-829-1954, which is the IRS Refund Hotline. If your use the automated system you will need to provide your Security number. You will also need to be ready to provide your filing status and the amount of your refund as shown on your return.
If you file electronically, allow at least 72 hours before you start checking on your refund. And if you mailed it, you need to wait at least three weeks before checking up on it.