March 31, 2023 – By Adam Shell
A tax refund is akin to a windfall. It’s like getting a big raise, a bonus at work or winning a scratch-off jackpot.
But going on a reckless spending spree with the cash is a personal finance no-no.
You’re much better off mapping out a plan on how to best utilize your newfound stash, personal finance experts say. And while the IRS says the average refund of $2,933 this tax season is down 11% from a year ago, that’s enough to prop up a weak household balance sheet. It can also replenish a leaky rainy-day savings account. Or, better yet, this extra money could bulk up your investment portfolio.
“The guidelines for using a tax refund comes down to using good judgment and planning,” said Allen Amadin, president and CEO of American Consumer Credit Counseling (ACCC).
Putting Your Tax Refund To Work
So, what should you do with a nearly three grand refund from Uncle Sam?
“It’s going to depend on each individuals’ situation,” said Rachelle Tubongbanua, a private wealth advisor at U.S. Bank. People with skimpy savings and a lot of credit card debt will have different uses for their tax refund than someone with solid finances.
When it comes to prioritizing what to do with a windfall there are three primary buckets to consider, Tubongbanua says. First, bolster your savings. Next, cut your debt. And lastly, add to retirement savings and investments.
Nearly a third of Americans said they’ll put their refunds into savings this tax season, according to a LendingTree survey. And 35% said they’ll pay piled-up bills.
In the pecking order of importance, doing the basic blocking and tackling of personal finance is the place to start.
Fill Up Your Emergency Fund
The first order of business is making sure you have enough cash stashed away to cover an unexpected expense, says Tubongbanua. The general rule is to have three to six months’ worth of expenses set aside.
That’s especially true if you identify with the 36% of Americans responding to a recent Bankrate survey who said they have more credit card debt than emergency savings. Or if you can relate to the two-thirds (68%) of respondents who said they’d be “worried” about having enough savings to cover a month’s worth of living expenses. Or you’re in the same boat as the 39% who said they have less in emergency savings than a year ago.
You don’t want to be caught in a cash flow pinch if you get laid off, your car conks out, or your roof starts leaking and you need money to survive your personal financial crisis.
It’s important to have cash on hand when the unexpected happens. Why? You want to avoid having to take on debt to ride out the storm.
“Make sure your emergency fund is fully funded,” said Tubongbanua.
And with interest rates high and inflation eating into your buying power, make sure you stash your savings in a high-interest bearing account, such as a money market, rather than a savings account with a minuscule yield. “Don’t leave money on the table,” Tubongbanua said.
ACCC’s Amadin recommends putting at least part of your refund in a separate account so the money’s just an ATM withdrawal away when trouble strikes.
Pay Down High Interest Debt With A Tax Refund
The Federal Reserve has been hiking interest rates for the past year to fight inflation. That’s making borrowing more costly than it was when rates were pegged at zero.
In fact, the average interest rate on a credit card is currently 20.35%, according to CreditCards.com. That’s a high bar to hurdle.
That’s why Amadin says “it’s time to reduce the debt load,” especially on credit cards with sky-high interest. Making minimum payments on your card each month will leave you with a hefty interest charge. So, consider using your refund to pay off debt and avoid paying interest charges.
Invest For Growth — And Tomorrow
A better way to shore up your personal finances is to invest a large chunk of your tax refund to build wealth — and invest your way out of debt, says wealth coach and “Your Millionaire Mentor” Cedric Nash. He is author of “Why Should White Guys Have All The Wealth? How You Can Become a Millionaire Starting From the Bottom.”
Nash says you should devote 50% of your tax refund check to your investment portfolio, 25% to pay down debt, and the remaining 25% to reward yourself.
“It’s a hybrid approach,” Nash said. “You want to build your future. You want to pare a little debt back. And you want to treat yourself, which kind of minimizes you from splurging.”
Nash admits that funneling half of a tax refund into investments, such as index funds, mutual funds, ETFs, stocks, or real estate, is an “unorthodox approach.”
Don’t Go Overboard Retiring Debt
But focusing too much on debt, he says, makes it harder to end the cycle of debt. He’s a proponent of using funds from a tax refund to grow wealth. Treat your tax refund like you do your 401(k) by adding regularly to your retirement or investment accounts.
With the stock market depressed due to the bear market, putting a portion of your tax return in the market will pay off later thanks to the growth potential of stocks.
“You want to build up your investment accounts so your assets can do the work for you,” Nash said. “Kickstart your portfolio. And get to the point where your assets can pay off your debt.”
Focusing all your efforts on paying down debt rather than using available capital to grow your money is akin to a rope-a-dope strategy in boxing, Nash says.
“You can’t win the fight that way,” Nash said. “Winning the (financial) fight requires power punches, and investing is your power punch.”
Double Your Tax Refund
Nash reminds investors that earning a 10% return will double their money every seven years.
And with the tax filing deadline not until April 18, it’s not too late to contribute to your existing IRA or open a new IRA for the 2022 tax year, says ACCC’s Amadin. You can contribute up to $6,000 or $7,000 if you’re older than 50. You might also be eligible for a tax deduction. You should also think about funding your IRA for the 2023 tax year with your refund.
“Saving for retirement is a form of self-care,” Amadin said.
