Spring is in the air. Now that Tax Day has passed and you’ve spent hours pulling together all of your income and deduction documentation to file your tax returns, it’s time to consider what to do with your tax returns. If you are like some 30 percent of Americans, you will receive a tax refund this year. A common question asked of CERTIFIED FINANCIAL PLANNER™ professionals each year is, “What should I do with my tax refund?”
Tax Refunds Explained
Advertisers are imploring you to spend that tax refund with them. Some will advertise “tax refund sales” to help you celebrate your “windfall.” The most aggressive may even offer to sell you their product based on a copy of your tax return with no cash down.
Don’t buy it, literally.
A tax refund is not “found money.” It’s not a gift. It’s not a bonus you were given for a job well-done or an inheritance from your aunt. So, if a tax refund is not newfound money, what is it? It’s merely a return of your own money that you overpaid to your taxing authority this past year. And now that taxing authority will be returning your overpayment to you.
You may have read that many taxpayers will receive smaller refunds this year than they expected, but you are still likely to receive some sort of return.
Regardless of the size, if you do receive a tax refund, what should you do with it? Consider this quote from Albert Einstein, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” Essentially, understanding how to use your tax refund will serve you in the future.
Therefore, it makes sense (and cents) to use your return to pay down your debts or invest your funds. Below are four ways to ensure you’re saving the “new money” rather than spending it on a new pair of shoes or vacation:
- Pay down credit card debt. Continuing to pay interest of 8 percent, 12 percent, 15 percent or 20 percent can be disastrous to any budget.
- If you don’t have any credit card debt, establish an emergency fund, aiming to save 3-6 months of spending.
- Another option to consider is putting that money towards funding your savings goals such as college, retirement or a down payment for a house.
- If you’re unsure where exactly to put the money away but you want to invest it, consider establishing, or adding, to an investment or bank account.
If this seems a little too good to be true, that’s because it might be. If you live in a state with state and local taxes, a refund from those entities may be taxable on your 2019 federal tax return. And it goes both ways. A refund from your federal return may be taxable on your 2019 state and local tax returns. In other words, your tax refund may not be tax-free.
A CFP professional is experienced and knowledgeable in the areas of taxes, budgeting, cashflow and goal-setting. He or she can help you prioritize your goals and objectives, identify risks and analyze your circumstances to help create a financial roadmap for your future, including what to do with a tax refund.
So, instead of shackling your tax return down with a new purchase, use it to relieve yourself of some of your outstanding debt, or to help finance your other long-term priorities. Remember, it’s your own money, so use it as wisely as Albert Einstein would.