April 15, 2016 in Taxes

Top 6 ways not to spend your tax refund

If you Google “how should I spend my tax refund,” the search engine spits out more than a million results. 

People seek answers to the question ever so urgently as the April 18 tax deadline nears and expectations rise that a check will land in their mailboxes soon.

It’s intoxicating, the thought of that money becoming available. A survey by Capital One of 1,000 adults, conducted March 2-5, found that 51% feel good about spending the refund on needs, but 23% wish they could spend it on what they want.

And while 56% view their income tax refund as money owed them and 17% see it as extra money for debts and needs, 12% view it as free play money, the survey shows.

“There are countless ways to misspend your refund: Vegas, the lottery, a brand-new automobile, hookers and coke. But rather than thinking like a consumer, think like a saver,” says William Davis, CFP professional, executive vice president of Apex Financial Advisors.

Here are 6 ways not to spend your tax refund in 2016.

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It’s tempting to view your tax refund as an unexpected influx of cash — like a bonus at work or a small lotto win that’s not devoted to any particular goal like your paycheck would be. Your monthly income is devoted to bill payment, saving for unexpected expenses and entertainment, if there’s enough left over.

The “free money” attitude can contribute to not thinking through the best use for it. In fact, it’s a good way to blow it, says Bill Hammer Jr., a CFP professional and author of “The 7 Secrets of Extraordinary Investors.”

“Don’t treat it like a $20 bill you found in your jacket and think about silly ways to spend it right away,” Hammer says.

He suggests using it first to pay down credit card debt. “This gives you an instant 15% to 20% return on your money,” he says.

If you don’t have credit card debt, start an emergency fund of savings for unexpected expenses or add money to your individual retirement account, or IRA.

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Tax season can be stressful, and if it’s been a cold winter and you’ve been cooped up indoors, it can be tempting to spend your refund on something fun, on a distraction from your daily life, says Dan Fisher, a financial adviser with Fisher Financial Group LLC.

“Don’t use your entire refund check or go on a pricey vacation. Remember, there are plenty of ways to save on a vacation,” Fisher says.

Bankrate advises charting out your travel spending and staying within a budget. The point is to plan ahead rather than go on an impulsive vacation the weekend following the arrival of your refund check.

Maybe you shouldn’t spend your refund on a vacation at all. In addition to paying down credit cards — a move that also will help improve your credit score — you could start a 529 college savings plan or add to one you already have.

“Then, claim that contribution as a deduction on your state return next year, if you are fortunate enough to live in one of the 31 states and the District of Columbia that offer upfront tax breaks for contributions to a 529 plan,” Apex’s Davis says.

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It’s funny how a little cash in your pocket makes you realize how much you absolutely need the latest (fill in the blank).

“If you didn’t need it before the refund, you probably don’t need it now,” Fisher says. “If you wouldn’t have paid for the much-needed item out of your paycheck, don’t use your refund for it either.”

Gary Swim, a retirement planner and owner of Swim Retirement, says an exception might be to use your refund for a tool or appliance that would encourage you to eat at home or help you in some other way.

“Some examples would be an espresso machine to cut down on trips to Starbucks or a deep freezer to store more meals,” Swim says. “You could also upgrade your grill.”

Another non-frivolous buy might be a portable generator. An ice storm or hurricane can be costly at best, devastating at worst. “This type of investment could really pay off,” Swim says.

If you do plan to pay off debt, Swim suggests that you create a debt worksheet to organize your credit card balances and use that refund to start paying them off.

“It will impact you all year,” he says.

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Fisher, the financial adviser, says it’s normal to want to help out family and friends.

“Unless you’re considering a legitimate peer-to-peer lending program, don’t get suckered into becoming a bank for someone else,” Fisher says.

Danny Kofke, author of “A Bright Financial Future: Teaching Kids About Money Pre-K Through College for Lifelong Success,” says it’s difficult to avoid the situation if family members know you’re getting a tax refund.

To be sure, it may come with some guilt involved. Many people don’t have the wiggle room in their monthly budget and can use a cash infusion. To avoid hassles and hurt feelings, Kofke advises against revealing that you’re getting a refund to anyone outside your immediate family.

“I personally don’t think it’s good to lend money to family members. It changes the dynamic of the relationship,” Kofke says. If you do lend money from your refund, don’t expect to get paid back.

Kofke says if you’re considering using your refund to become a lender on a peer-to-peer lending site, you might rethink the strategy because you may not get your investment back.

“It can be a slippery slope. I would not recommend doing this until you have ample financial margin in place, in case this doesn’t go as you planned,” he says.

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You receive your tax refund check in the mail and you don’t have a strategy for spending it. So, you drop that money into your checking account as a short-term move while you decide.

If it stays in your checking account for any length of time, that’s a wasted opportunity to scarf up a small return, since it’s so easy to move that money into an interest-bearing savings account, says Daryl Patten, vice president of Fort Pitt Capital.

There’s also the possibility that you’ll drain your refund to cover small unexpected daily and weekly expenses. “We all put extra money into a checking account, and if you don’t move it then it will go away,” Patten says.

Jessie Seaman, an attorney with the Tax Defense Network, says even putting your refund in a savings account doesn’t go far enough.

“Playing it safe is always smart, and you certainly can’t go wrong with tucking your refund away for a rainy day. But simply dropping it into your savings account might not be the most efficient or lucrative option,” Seaman says.

“You may consider a high-interest bond, or perhaps consult a financial adviser regarding smart, long-term investments,” Seaman says.

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Some people use their tax refund to catch up on monthly expenses, but financial advisers say it’s a bad way to move back into the black.

“The important thing you shouldn’t do with your refund is count on it. If you are waiting for your refund to arrive to pay rent or your bills, you can end up in trouble,” Fisher says.

Seaman agrees, and there’s a good reason for it.

“The government may take longer than you’re expecting to process your refund. You might get lucky, but there are a number of reasons why there might be a legitimate delay in getting your payment from Uncle Sam,” she says.

Fisher advises people with monthly debt problems to establish a plan to get rid of high-interest debt — credit cards, car-title loans, debt-consolidation loans and private student loans, so that typical monthly bills won’t be so onerous.

“Put your refund to work by starting your own debt elimination program,” Fisher says.

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