Every year the Internal Revenue Service returns hundreds of billions of dollars to tens of millions of households that overpaid their taxes. Last year, approximately 109 million filers received more than $300 billion in refunds, for an average of $2,782.
At the same time, a troubling percentage of Americans lack adequate savings, and an even larger cohort have so little saved for retirement that they might as well have nothing. Nearly one-in-three adults use their refund to pay for basic necessities.
You need this money. Here’s what you should do with it.
What is a tax refund, really?
A tax refund, by definition, means you’ve overpaid your annual tax debt to Uncle Sam. You aren’t receiving extra cash, but rather regaining what is already yours.
Many financial planning experts will tell you that leaving money with the government is a less-than-optimal savings strategy. Are you really in a position to offer the federal government an annual $3,000 interest-free loan?
The proliferation of hacked personal information, from Social Security numbers to home addresses, has made this giant pile of cash a ripe target for criminals. Why not inoculate yourself from that scam by paying only what you should pay?
Of course, tax refunds are also a forced savings mechanism. Americans struggle to put money away, while also paying for their lives, so the tax refund operates like a de-facto savings account every spring.
Overpaying also insures that you won’t owe extra when it comes time to file your taxes.
Reasonable people can disagree whether a large refund is a positive or negative, but at least be conscious about which path you’ve chosen.
Arguing about the efficacy of a refund is beside the point for tax year 2017–at this point, you’re either getting something or you’re not. If you are, how best to utilize it?
Ideally, you’d bank it.
The average American struggles to save, and a $3,000 jolt can go a long way. Only 39 percent would pay for an unexpected $1,000 emergency out of their savings account, according to a Bankrate survey. Among those with anything in an account, they only have an average of $4,500, per the Fed.
Aim to have six months’ worth of essential spending secured, which, depending on your income and living expenses, is about $20,000. An averaged size refund will get you 15 percent there.
Pay down debt
Owing credit card debt, however, can complicate a clean savings surge.
A larger safety net should give you more leeway to aggressively pay down your credit card IOUs.
Don’t think you suddenly have more fuel to burn.
Buy yourself something pretty
That’s a lot of spinach to digest.
Growing your savings, while reducing debt, can feel underwhelming even if your personal finances improve.
There’s nothing wrong, then, with taking a small bit of your refund and using it for fun. Go out to dinner with your spouse. Buy that bottle of wine you’ve eyed. Donate to those less fortunate than you.
A small, but meaningful, purchase will fortify your resolve to be the best version of your financial self.