about tax refunds
A check from the IRS can fill many needs.
But don’t think of it as a gift.A check from the IRS can fill many needs.
But don’t think of it as a gift.
If you're like some 50 million other Americans, you can expect to receive a tax refund this year—unless, of course, yours has already arrived, in the mail or deposited directly in your bank account.1 But how will you use it?
Until about a decade ago, when the economy was on a surer footing, tax refunds were commonly viewed as found money—a kind of "Christmas-in-April" gift from the IRS one could spend without guilt on a much-desired splurge.
The reality, however, is that a tax refund isn't a gift or a windfall. Rather, it's repayment of an interest-free loan you've made to the government by having too much money withheld from your paycheck. You're only getting back what was yours to begin with.
The distinction is important. Regardless of what you choose to do with your refund, it's not largesse but income that you've earned, carved out of your salary and returned to you at a later date.
The anti-splurging trend
In point of fact, most people these days do refrain from spending their refunds on non-essentials. According to the Corporation for Enterprise Development, the average refund received by 73 percent of U.S. households last year was $2,953.2 But only 7 percent of refund recipients this year will spend the money on vacations and luxury purchases, according to a Bankrate.com poll. Eighty-four percent have other plans for their tax refund, such as saving or investing it (28 percent), paying off debt (30 percent) and covering day-to-day living expenses, like food and heating fuel (26 percent).
The behavioral shift from splurging to saving owes much to lingering uncertainties about the economic recovery. Of course, in any economic environment, there are probably better things to do with a refund than buy stuff with it.
Saving, investing it or paying down high-interest credit card debt can be smart choices. Likewise adding it to your retirement nest egg or rainy-day fund, or contributing to a child or grandchild's college fund. The IRS actually makes saving easy: You can arrange to have your refund deposited directly in up to three separate accounts.
It may even be to your advantage to shrink the size of your refund—and increase your take-home pay—by raising the number of withholding exemptions you claim.
Thinking strategically about your refund
Admittedly these may strike some people as sensible but unexciting eat-your-vegetables options. But there is no hard-and-fast rule against spending your refund on a 96-inch Smart TV or a vacation in the Caribbean. What you do with it should be determined by your personal aspirations, needs and situation. The point is to allocate your refund dollars—whether to luxuries or necessities—as carefully and strategically as you do your paycheck.
Approaching a tax refund with that mindset can move you a step closer to your financial goals—short-, mid-, or long-term. That can be the biggest windfall of all.
This information is made available to you as a self-help tool for your independent use and is not intended to provide investment advice. We cannot and do not guarantee its accuracy and applicability to your individual circumstances. All examples are hypothetical and are for illustrative purposes. Please consult with a financial advisor for a solution suitable for your needs.