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Tax Refunds and Financial Responsibility

Tax refundThe very same week our accountant (my father) informed us we would be getting a $1,550 tax refund (thank you, 2016, for the purchase of our first home and birth of our second child), my husband and I discovered a sizeable leak in our garage roof. So now, instead of using that money for a home repair we actually wanted to make, or to boost our savings account, or add to college savings plans, or more likely, to help pay for two kids in diapers and daycare, we’re buying a new flat roof. Lucky us. But this episode got me thinking—what do most people do with tax refunds? And what do CPAs advise they do? Is there a happy medium between fiscal responsibility and fun?

Aim for No Refund at All

First and foremost, the goal, according to most CPAs, is to not get a refund. While many people love getting a large chunk of change every spring, it indicates you’re overpaying and essentially giving the government an interest-free loan. Getting no refund at all means you’re paying the IRS exactly the right amount. Of course situations change from year to year (see my home purchase and birth of kid references above) so you might not always get it right.

Too Late, I’m Getting a Refund. Now What?

If you do receive a refund, there are a number of ways to make the most of it.

  • Clear your slate. If you have any high-interest debt (think credit cards), pay it down. If you own a home and have a mortgage, consider making an additional mortgage payment for the year. It will help cut down on the amount of interest you pay over the course of the loan. You may also want to consider paying off student loan debt or car loan debt, depending upon your interest rate.
  • Consider investing your refund to help your money grow. There are many tax beneficial investment vehicles to consider, such as a traditional or Roth IRA, 401(k), etc. A CPA/PFS can help you with financial planning. Whether this means squirreling the money away in retirement accounts, college savings plans, or in a regular old savings account to help you grow your nest egg, you can’t go wrong.
  • Make a strategic purchase. Driving a 15-year-old car? Need to upgrade your 5-year-old laptop? Looking to make a home improvement? Using your refund to make a large, well-thought-out purchase may be the way to go.
  • Make memories. Do something fun! If you are working hard toward building your savings and have paid down debt, don’t be afraid to earmark some of your refund for a vacation or other experience. A recent survey shows kids remember the vacations they go on with their families way more than they remember “stuff.”
  • Adjust your withholding and/or estimated tax payments. Speak with your CPA about how to get closer to the goal of zero refund in the future and what adjustments need to be made. Plus, if you’re like most taxpayers who pay the IRS via payroll withholding, having a little more money in each paycheck is nice.

If you’re thinking “what refund? I always owe” you should consult your CPA about adjusting witholding/paying more in estimates. One CPA I spoke with suggested maxing out 401(k) contributions and other benefical pre-tax deferrals to lower taxable income to avoid owing or at least lowering the amount you owe.

So what do people actually do with their refunds? A survey of my colleagues revealed answers all over the map:

  • Make home improvements—a new fence, “fun” renovations
  • Pay down debt
  • Put money into savings
  • Buy a new car to accommodate a growing family
  • Stick to the 3-3-3 rule
  • “What refund? I owe!” (See, even those of us working in the financial world aren’t always perfect!)

What Not to Do With a Refund (A Cautionary Tale from my 20s)

Long before I was using a refund to begrudgingly pay for unexpected home improvements, I was a fiscally irresponsible 20-something just starting out, making what felt like three pennies an hour. In those days, I spent my refund in my head before my accountant father had even begun filing my taxes, which was usually around April 12—he’s early this year! One year I bought my then-boyfriend a bike for his birthday. And a few days later got stuck with the bar bill at his birthday party when several guests skipped out on the check. So essentially I bought him two birthday presents, and soon enough after this debacle, we broke up. I know, I know. Financial disaster. But I’ve learned since then!

Other things to avoid doing with a refund:

  • Making a large purchase when you have outstanding high-interest debt (i.e., live beyond your means)
  • Heading to the casino
  • Loaning people money (at least avoid loaning non-deserving people money)
  • Letting it sit in a zero-interest account
  • Buying a boat/pool/other large purchase that could increase your liability insurance and otherwise cost you a ton of money in maintenance

While it might be a drag to take a cautious, responsible approach to a tax refund, it is an investment in your financial well being, which is something you’ll never regret.

And what better time to make smart money choices than Financial Literacy Month (April)! For more tips on how to make great financial decisions, check out 360finlit.org and join in on the #360lifegoals challenge.

Lauren J. Sternberg, Communications Manager, Association of International Certified Professional Accountants.

Tax refund courtesy of Shutterstock.

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