If you are one of the millions of Americans slated to receive a tax refund this year, why not make your refund work for you? Of course you will be tempted to splurge on a vacation, start home renovations or maybe even buy something frivolous, but why not use it to improve your financial situation.
If you are struggling with debt, have little to no emergency fund, or haven’t even begun to think about retirement those refund dollars could make a big difference. Reducing your debt and preparing for the “what if” are a great way to reduce daily stress and will point you in the right direction for reaching your financial goals.
Knockout Your Debt
Paying off even one of your credit cards in one lump sum can make a huge difference in how much you’ll end up paying long-term. To see just how much, enter the amount of your debt, your annual percentage rate, and the amount you usually pay each month in this Credit Card Payment Calculator. You may be shocked when you see the results.
For example, with an average interest rate of 18.75% and assuming you make minimum payments of $10 or 4% (whichever is higher), eliminating $500 of credit card debt will save you $230 in interest over the 5 years it would have taken you to pay off the debt with minimum payments. As a return on investment, that’s a 46% profit!
After you’ve paid off your credit card, share your success with others! Visit the Debt Movement Community to share your story. Bragging about being debt free can be just as exciting as money spent on something frivolous.
Invest In Your Future
If your debt is under control, or even if it isn’t investing in your future is a wise choice. The beauty of investing is time. Time allows your money to grow and compound. Even a little invested money can make difference years down the road.
For example, $500 invested at an average annual rate of 8% will be worth $745 in five years, $1,110 in 10 years, and $2,463 in 20 years, and $5,468 in 30 years.
So if time is on your side, using your refund to invest is a painless way to spend your “found” money.
Get Rewarded
If you apply your tax refund towards a tax-deductible investment, you can earn even more money!
For example, if you invest in a 401(k), your $500 tax refund could generate an additional refund of $125. That’s a return on investment of 25% .
Then you can use the $125 refund to pay off a debt or even invest that too.
Next Year Keep Your Money
You can reap the rewards of your hard earned paycheck before tax time by making sure you don’t get a refund next year. If you are receiving a refund each year the government is actually the one earning interest on your money.
You can arrange to have less tax deducted from your paychecks so you can enjoy your “refund” every time you get paid. Of course it won’t be in one lump sum, but can still be used the same way; to aggressively pay down your debt and invest in your future.
To keep yourself on track consider having savings automatically deducted from your paycheck and funneled to the investment of your choice. Or, set up an account specifically for debt payments to keep you from spending your refund.
Are you getting a refund this year? If so, what are your plans for it?
Years ago before we got all frugal and sensible and before kids we probably would have done something fun with our small refund. When our kids were little we did get bigger refunds because of the child care expenses we could write off, but with young children we always had lots of places that refund needed to be spent. We no longer have childcare deductions, but our salaries have increased, and we’ve frugalized our lives and freed up a lot more to make larger retirement contributions so our refunds are substantially bigger, and definitely don’t get frittered away on fun or nonsense (geez don’t we sound like a fun couple?)
In Canada the deadline for 2012 contributions to your RRSPs (like a 401K) is March 1st. We’ve made most of the contributions we indend to for the 2012 tax year, but often in the last few days of February after I’ve roughed out our tax returns to see where we stand I’ll decide to throw in a little extra. My husband is in the next higher tax bracket from me, so he makes all the contributions in his name to my RRSP (called a spousal RRSP). He gets the deduction on his taxes and my account gets built up. Years ago his retirement account got seriously ahead of mine thanks to a great severance package. Even without that, financially it makes more sense to reduce his taxable income at least until he gets down to the same tax bracket as me, and after that it doesn’t matter. Preparing our tax returns before the contribution deadline means I know exactly how much more he needs to contribute before he drops down a tax bracket. Taxes aren’t due until
I generally borrow from our line of credit to make the final last minute end of year contribution, file the taxes online, the refund is deposited electronically into our account 7-10 days later and I pay off the line of credit. We pay a tiny bit of interest for those few days but it’s a convenience tax I can live with. If we throw in a few extra thousand (at ~40% income tax rate) the refund is substantial. The refund on the contributions already made through the year along with the last minute ones will more than cover the amount borrowed, and the rest of the refund goes to our mortgage which is our only debt. We can pay off up to 15% of the original amount of the mortgage every calendar year in addition to our regular payments. So I normally get started on that with a portion of the tax refund.
We paid off the line of credit years ago, but keep it open for just this sort of activity. It’s a handy way to make a large purchase which will be paid of very quickly, without impacting your normal cash flow. At this point in our lives, retiring early is our big priority and our exit date is directly tied to reaching our savings target and being mortgage free. Personally I can’t think of anything I’d spend that refund on that would be more enjoyable than moving up my retirement date. For easy calculations, I assume retirement will cost us $100/day. I tend to look at our refunds as x days of retirement which puts it in perspective for me.
@JMK That is a really interesting idea; borrowing from a line of credit for the short term loss and long term gain of early retirement! Sound like you put that refund to good use 🙂
I’m going to apply it all towards student loans! 🙂
@Michelle I hope others that have student loans will do the same. Often considered “good” debt student loans can be a financial killer! Thanks for sharing!
$800 will go to return our $1500 EF savings account to where it should be (we dipped into it for car repairs recently). $1500 will go to pay for a Disney vacation in cash. Woo hoo! Never paid for a vacation with cash before. The remainder will pay off one stubborn balance on a credit card that will be fully paid off.
@Kaye Your refund is going a long way–and a little fun is good for everyone 🙂 Enjoy your Disney vacation…and don’t take your credit cards!
Well, we were going to save our money for our next down payment, but then we received our medical bills for the baby and our couch broke. Instead of saving, I am going to pay off all of those debts and be done with it. What is the point of saving with a less than 1% interest rate if you have to pay down debt. Stupid debt!
@Grayson I second that…stupid debt! Paying down high interest debt first will save you in the long run. Congrats on the new little one 🙂
Excellent suggestions! Love the numerical examples, really helps make your point concrete. Thanks.
Thanks glad they were helpful 🙂
Sounds crazy, but we deliberately try to overpay on taxes during the year so we can get a refund. It’s not alike we lose a fortune in interest, and when your money is with the IRS, YOU CAN’T POSSIBLY TOUCH IT! 🙂 Some people say that like it’s a bad thing, but we just like it like that. One year we ended up underpaying our taxes for some reason and we got hit with a penalty. We started having payroll taxes withheld at “single, zero” to avoid the penalty, and then we discovered how well it ended up working as the “annual bonus.”
Oh, and talk about the incentive to file as early as possible. No more procrastination and April 15 stress here anymore!
So, our refund doubles as a top-up on the emergency fund and the budget for anything we want to do in the coming year (repaint the house, etc.).
Whatever works, right? 🙂
@William Actually your strategy is a great one especially for those who just can’t seem to save! A forced savings from the IRS is better than no savings at all; especially if you use your refund wisely 🙂
Our refund go toward student loans or the student loan pay off fund. I try not to get a large refund but this year was my first year with a schedule C so I played it safe with a larger than necessary estimated payment.
@Lance Better to be safe than sorry; overestimating and getting a little back is better than not paying enough and having to pay in, especially if you didn’t budget for for it 🙂
Great post! We actually work it so we can come as close to 0 as possible. When I was in debt I would use it towards paying it off or saving it. If we get one this year it’ll likely be thrown as retirement saving as we had to put that on hold last year with expanding our business.
@John S Thanks! Saving for retirement is a hug win–every little bit counts 🙂
This year I had a state refund of $1,039 and I owe the IRS $370. I have already received my state refund, 1k went into my trad IRA and $39 went into my savings account. I will pay the IRS on 4/15 (EFT from my checking account is already set up). And yes, I claimed the 1k trad IRA contribution on my returns. 🙂
@Petunia100 Woohoo! All wise choices, good for you!
This is the first year that I don’t feel a rush to send in my taxes, even though we will be getting back a total of $1500 between federal and state. I probably will put all of it in our EF, as that is the biggest goal I have for this year. A fully funded emergency fund is the best way to honor my windfalls! :)!
@Sharon Congrats on being able to sock away your refund into your emergency fund! Now you can focus on other financial goals for the year 🙂
The first $100 will be for a pantry filling trip to the grocery store and a new bra. I was going to split the rest between debt and retirement savings but I have a household repair emergency and so the money will go towards a new kitchen window that will help me to feel safe in my home.
@Jane Savers A stocked pantry is a great way to keep from overspending by making those last minute grocery trips 🙂 Hopefully the repair will be reasonable and you can use a little to pay down your debt!
About half will go to savings, the half will go to debt repayment. I typically get smallish refunds so it doesn’t make a huge difference in my budgeting. I might also do a pantry trip as well.
I knew we were getting a refund as soon as I filed last years taxes since I was owed a graduate rebate (Canada) with me being on mat leave (for a year) instead of screwing our day-to-day (tight Mat leave) budget with saving for our family reunion this summer (which has been in the plans for 18mos) we’re using our refund for that+paying off 1 debt (500 bucks)+300 for a home repair and 100 for us to do a costco trip for items we usually buy once or twice a year 🙂 if there was no reunion 99.9% would be on debt.
We got married last year, so this is our first time filing jointly (what an adventure that was!) We owe the Feds $100 and are getting $300 back from the State, so we’ll probably use the $200 to have a little anniversary celebration since we put a pretty hefty chunk of our paychecks toward savings and debt. By the time our refund arrives, we’ll be debt-free!
Does anyone know how much a typical refund is in the US? In Canada? Just curious.
We do virtually all our retirement savings outside of work (no plan for me, no matching and terrible fund options for him) so we are entitled to the full tax reduction long after the contributions go in. If we were making payroll deductions and having our taxes reduced at source our refund would be far smaller. I know we could tell work to deduct less tax, but I’d be nervous that our plans to contribute $x through the year wouldn’t happen for some reason and then we’d owe a ton of tax. If they just reduce tax as they toke the savings off our pay they’d stay in sync. Then we’d only have our miscellaneous deductions to process ourselves for a much smaller refund (kids sports/arts fees, additional retirement savings done outside of work, student tuition expenses transferred from son, etc.
We are quite tempted to travel for our tax refund actually but we need to think it through first and think about what’s more important right now.
I plan on using my refund to help me get by until I start school in Fall. Having just finished my military service, I plan on living off my emergency fund until the GI Bill kicks in when I start my MBA.
Of course having the money in the bank now collecting interest would have been better. Unfortunately most of the return is from education credits, I try to underpay taxes if possible.
Watson
moneysgt.com
Save all of it for moving expenses! My husband and I are moving across the country for my husband’s new job. We saved a lot of money last year knowing this was coming, but since our tax refund was more than we expected, we decided to put it toward our move. Whatever is left over will be split between our emergency fund and short-term savings account. . . that is if the move doesn’t gobble the whole thing up!