Five Good Ways to Spend a Tax Refund, and Five Bad Ways

Many people treat a tax refund as “found money” or “free money.” What they don’t realize is that it’s their money, and always was. The money was an overpayment of taxes owed, which the government was happy to receive as an interest-free short-term loan.

Once you start thinking of your tax refund as a portion of your income, and not as free money, you’ll rethink the way you spend your tax refund. Rather than wonder, “Why is my refund so low,” you’ll think, “Yay, my refund is low!”

Five Good Ways to Spend a Tax Refund

Here are my top five ways to spend a tax refund:

  1. Don’t receive one! The best way to spend your refund is to never receive one in the first place. No, I’m not suggesting you donate your refund to the government. I’m suggesting that you adjust your tax withholding to ensure that you only withhold what you owe. This year my husband and are receiving less than $200 from our federal and state tax refunds because we managed to pay almost exactly what we owe. (It was an accident this year, but we intend to do it again.)
  2. Pay down debt. If you owe any debt, use your refund to pay it down. That’s where our tiny tax refund is going.
  3. Boost your emergency fund. If you don’t have any high-rate debt, then use the money to boost your emergency fund. Even adding a little bit to an interest-bearing savings account can help you out in a pinch.
  4. Invest it. The average family receives a $2000 refund. If you’re one of them, that’s a pretty sizable investment. If you were to deposit $2,000 in a Roth IRA at age 35 and average an 8% return, you would net $20,125 by age 65 without adding another cent.
  5. Spend a little and save the rest. If you’ve been frugal all year long, reward yourself with a nice bottle of wine or a nice night out, then save the rest. Don’t overdo it, but spending $50-$100 is a good way to treat yourself every now and then.

Five Bad Ways to Spend a Refund

I have to admit that I’ve been tempted to waste tax refunds in the past. Especially when I didn’t have any debt – I just spent it whenever I felt like it. Now I know better. Here are five bad ways to spend a refund:

  1. Blow it on a vacation. Many people use their refunds as vacation funds. There’s nothing wrong with taking a vacation if you can afford it, but it shouldn’t depend on whether or not you receive a tax refund. Instead, adjust your withholding to the correct amount and save the additional money you receive in your paycheck. Simply divide the amount of your previous year’s refund by twelve and deposit that amount into a savings account every month. Even if you only earn $20 in interest, that’s $20 more than you could have spent on vacation if you’d simply used your refund.
  2. Blow it on clothes. We all need clothes. No one needs a $2000 pair of shoes. Buy new clothes if you need them, but don’t go on a shopping spree just because you got a refund.
  3. Blow it on a big screen TV or another large, unnecessary purchase. If you wouldn’t buy it without the refund, then don’t buy it because of the refund. Instead, save up for it. If you still want it after months of saving, then go ahead and buy it.
  4. Fritter it away. Even if you don’t set out to waste it, not having a plan for the money could be just as bad. If you think, “It’s only $10. I got that refund, so it’s fine,” those purchases will add up quickly. You could wind up spending more than the refund.
  5. Stick it under your mattress. My friend’s father didn’t trust banks (he was from WWII Germany). When he died, his family found over $30,000 in cash tucked away in boxes and stuffed under the mattress. Imagine how much more money he would have had it if he’d put it in safe investments or a savings account.

Now that I’ve shared my tax refund strategies, how do you plan to spend a refund? Have you ever wasted it? Do you have any good ideas for spending it? Tell me in the comments.

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