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10 Smart Ways to Spend Your Tax Refund Money Wisely

By Pat S

cash envelope tax returnIf you’re expecting a tax refund this year, you need a good plan for your money. Maybe you already have the funds earmarked for some spending, but before you let your tax refund burn a hole in your pocket, remember that the government isn’t sending you a bonus check – it’s money that should have been yours all along. In fact if you’re receiving a huge refund, you’re probably having too much withheld. Be sure to revisit your W-4 form and adjust your federal income tax withholding allowances.

Don’t get caught treating your refund check any differently than you’d treat your weekly or monthly paycheck or if you own a small business, revenue from your customers. Give the money a purpose. Don’t just let it sit in your checking account. If you do, it will quickly vanish after you use it for dining out here, shopping for clothes there, and getting Starbucks every day. Before you know it, you’ll have nothing to show for the refund.

Think about your personal financial situation, and figure out your needs. To get you started, consider this hierarchy of financial priorities, from the fundamentals to advanced strategies.

Top 10 Priorities for Your Tax Refund

1. Start or Increase Your Emergency Fund
Without an emergency fund, just one surprising piece of bad news can send you on the debt spiral to financial disaster. Most experts say that your fund should have about six to eight months worth of savings in an easily-accessible interest-bearing account (e.g. an online savings account or money market account). Storing that much away might take months or even years if you’re just taking a little bit out of each paycheck, so use your refund to make a significant deposit in your emergency fund.

2. Pay Off High-Interest Debt
After establishing an emergency fund, the next best thing you can do with your tax refund is to pay off any high-interest debt that you’re carrying. If you have a lot of debt, just putting money in savings is like borrowing money from yourself. Put your refund to work by starting your debt elimination program of choice and paying off any payday loans, title loans, debt consolidation loans, high-interest private student loans, car loans, and of course credit card debt.

3. Spend It on Something You Need
Are you having car trouble, do you need a new winter coat, or have you put off dental work? You need to take care of these essentials, and now that your refund is here, you can cover the cost.

4. Start Itemized Savings Accounts
Now is the time to start practicing the mindset of the disciplined and frugal consumer. First make a budget, and then break your refund into pieces, each of which plants the seed in your bank account for important future purchases. Putting your refund toward specific savings goals will keep you from taking on debt down the road, when needs or desires arise. Capital One 360 offers some great features that allow you to set up these specific savings goals in your account.

5. Refinance Your Mortgage or Make Home Improvements
Mortgage rates are below 5% for the first time since the housing boom, except this time the price of homes is far less than they were in 2004. When you refinance your mortgage, you will still pay closing costs and fees. Use the refund to pay for the closing costs, and you will save thousands of dollars per year on mortgage interest.

If you’re happy with your mortgage rate, take a look around the house. Do you need a new roof? Is your kitchen outdated? Could new energy-efficient appliances save you money on your utility bills? Home improvement projects can immediately increase the value of your property and make your home more comfortable at the same time.

6. Invest in a Tax-Sheltered Account
Depending on your income level, goals, age, and whether you have already fully-funded your tax sheltered accounts, using your tax refund to get a head start on Roth IRA contributions or 529 college savings plan contributions is a great move, one that can let your three-digit tax refund grow into to a four-digit addition over the course of a few years. Plus, it’s like using your tax refund to create a tax deduction: How does that sound?

7. Invest in a Taxable Account
Have you already contributed the maximum to your tax-sheltered accounts? Give yourself a pat on the back and consider opening a brokerage account with a discount broker (e.g. Scottrade, TradeKing, and Sharebuilder). Lean toward conservative and diversified investments with low expenses. Check out some mutual funds. Index funds or ETFs may be a good choice for you, especially if you are not interested in actively managing your stock portfolio. They offer instant diversification and very low expenses.

8. Give to Charitable Causes
For many people, giving to charities is non-negotiable, and would be priority number one. But on a tight budget, donations can unfortunately slip down on your list. Your refund is your chance to give a little back. Contributing to charity is an excellent use of capital, and provides a huge societal benefit. Choose a cause that is important to you and your family, and give generously. Although the returns on your investment may not be as immediate or measurable as investing in the financial markets, giving to charity will benefit your community in a major way, and you can claim the tax deduction too.

9. Get that Business Up and Running
Have you been looking for seed money to take your business to the next level? Do you have a venture that you want to start? You can use your refund to get you moving in the right direction. It’s a great opportunity to turn your refund into income for years to come, and get a few more small business tax deductions next year too.

10. Spend It on Something You Want
If you made it to priority ten and still have some money left to spend, so you deserve a treat. You saved all year, and now you’ve earned the right to splurge a little bit. Don’t feel guilty about using the extra cash for a summer vacation or to treat your family to a nice dinner. Just don’t let your eyes get too big for your stomach. A $500 refund is no excuse for a $3,000 trip.

Final Word

If you’re getting a tax refund, regardless of the amount, it’s a big deal to get your money back. Whether it’s a windfall or just a drop in the bucket, your refund should feel like “found money,” and if you’re smart you can put it to work for you and improve your financial situation. You can even treat yourself, but don’t blow it at all the mall or splurge too much, like on a new car.

Are you getting a refund this year? What do you plan to do with it? Are you smart with your money, or do you tend to quickly spend your refund?

(photo credit: Shutterstock)

Pat S
Pat S is an active duty military officer. On his off time he enjoys working out, reading, writing and spending time with his dog. Pat became interested in personal finance after several costly mistakes early in his military career that could have been avoided by a basic understanding of personal finance.

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  • http://www.budgetpulse.com Craig

    I plan on finally opening up an IRA retirement account so I can get that started with, instead of buying something I really don’t need.

  • http://wiser-investor.blogspot.com/ Daddy Paul

    Good list. I sure like the idea of paying off high interest debt. Just think about a 20% credit card bill. Where else can you invest your money and get a 20% return?

  • avalan

    If you missed out paying or filing late taxes for the previous year, it is still possible to work it out.

  • http://madsaver.com Mac

    I usually immediately transfer the money to my paltry savings account and pretend that I never received a refund. Did just that in February to help replenish the account from recently getting a new driveway.

  • Claudia

    I wish I woul have money coming to me this year in a refund bu I dont. Last year, I did and used it to pay one month extra in my mortgage. I first found out that there was no prepayment penalty which there wasnt and I did this as a cushion but also as a way to reduce my overall money owed at the end of my mortgage.

    • http://madsaver.com Mac

      Not a bad idea, but paying off the mortgage quicker won’t save money for everyone. Really depends on the interest rate. Ours is now under 4% (1 year arm), so my money is better invested elsewhere than paying down the mortgage. But excellent in times of higher interest rates as it’ll save a lot of money in the long run.

  • Karmella

    Straight to ING- if CD rates were better I’d put it in one of those.

  • http://toxic-shock.blogspot.com Atom Shock

    Try as I might, I adjust my withholdings every year to put more money in my paycheck and break even on taxes and not give the government an interest free loan, but I still end up getting a refund. I use it to pay my NFL season tickets which are due in March. Any left over goes into savings.

  • gina

    I personally do not have any refund coming back, but if I did I would be paying down my debt!

  • Em D.

    I never think of my refund as extra money to spend, it just goes into my savings account. For me, spending money as soon as it comes in is a good way to not have savings.

  • Jeccica Simpson

    I wish could apply my tax refund $$$ to anything on the list, but as always something happens and something comes due, hopefully someday that will change.

  • http://www.castocreationsjewelry.blogspot.com megscole64

    I’m GLAD that we don’t have a refund. As painful as the check is to write, I know that we were able to use our money all year without loaning it interest free to the government. It still amazes me that people think it’s “found” money. Such a waste.

    • Winston

      So true!!! I am glad somebody mentioned it. Getting a tax refund from the government is not a good thing as it is your money to begin with. You let the government use your money without paying interest. What a rip-off. :)

      • Karmella

        I understand the principle for sure, and I even agree with it – but I can live with knowing that I gave them an interest free loan and I didn’t have the miserable experience of actually writing a check. That makes me so unhappy and outs me in such a bad mood that I’ll happily make the tradeoff.

        • Jim

          I agree. Even though it is essentially an interest free loan to the government, how much interest are you really losing out on with the interest rates that banks pay out? I have owed money and received refunds and it is much more painful to write out that check to the government on April 15 than it is to think about the few dollars in interest I lost out on.

  • Winston

    Well, I didn’t pay extra money to the IRS last year. The refund that I got was from the “Make Work Pay” credit, which is a little over 100 dollars. I used half of it to get myself a comfortable chair because my old one has been literally a pain in the ass. The rest I put in Wachovia’s Way2save saving account.

    • http://madsaver.com Mac

      Sounds like money well spent to me. Being comfortable is an investment in your health. My next furniture purchase will be a new bed as the current one is giving me back pain and is already 10 years old. I thought of using my tax refund on it, but as my situation is a bit up in the air right now, I thought it be better to save all of it in case it’s needed.

  • http://sofinancialrenovation.com Sian Owen

    I really believe when you get money back – – just like with a bonus – – you should always spend a portion on yourself. A small portion say 10 – 20%. That way you avoid any feelings of resentment or deprivation. Split the remainder: 50% pay down high debt and 50% for emergencies. Its best if the emergency funds are held at a an online bank with a higher rate. There are two benefits. The first is you don’t see it everyday so you don’t have it in your sights as spendable and second is the higher interest rate! If you have no debt…follow the rest of the list :)

  • autum

    My husband is considering a better heating system for the house. This old house will need insulation as well since its got none in the first place. And i need a more reliable use vehicles that doesn’t cost as much a another one to fix. A big list of what to do but not a lot of money to work with.

  • Juanita Patrick

    i have a sick habit of spending all my money on things that won’t even matter (or get used) 6 months down the line. lesson learned! a huge chunk (already calculated out) is going to that emergency fund, and the rest will pay a crucial bill and fund the cost of training at bartending school. time to grow up and get my finances in order

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