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It's tax season. It's the time of year where tax commercials are played constantly. From the H&R Block's "It's Refund Season" to the Jackson Hewitt "This is how we do it" commercials, we are lulled into sleep by the fact that it is a good thing to get a tax refund. In all reality, a tax refund is just the government paying you back the money that you loaned them over the course of the year. That's right you essentially loaned the government your hard earned money and they didn't pay you any interest.
Years back, I would receive a tax refund and I thought that it was perfectly normal to do this, but recently I have researched and studied this topic and I have learned that a tax refund is not the best way to handle your money. So, instead of receiving a tax refund, I have set up our finances in a way that we either have to pay in or we get a very small refund. Last year, we paid $2,000 in taxes in February. I was fine with this, because we had the money in savings and the money in savings was earning interest the entire year. So, we made money on that $2,000 dollars instead of earning nothing on money from a tax refund.
Now, I understand that receiving a tax refund seems normal and most of us have received them over our lifetime. But if you want to change the fact that you receive this refund, then you can update your W-4 to reflect more dependents. I believe that receiving a tax refund is unnecessary, but what do you do with your refund if you are receiving one this year?
Smart Ways to Spend Your refund:
- Saving or Investing - This is a smart decision. Anytime you get a large lump sum and put it in savings or invest, then you are making a smart decision.
- Pay off Debt - I personally hate debt and this would be the first place that I would spend my money if I received a tax refund. There is no better thing that being free from debt.
- Saving for a Down Payment on a Home - Houses are wonderful things for people who are financially stable. Your tax refund, could go towards the purchase of a new house and that would be a smart decision.
- Giving - As we discussed earlier, you can never go wrong when you are giving your money to help people in need.
Not very Smart Ways to Spend Your Refund:
- Down Payment on a Car - I am not a big fan of debt, but there is a trend in my area to use the tax refund as a way to buy a brand new car. So, I would not support a decision like this. If you can't buy the car with cash, then you should never buy the car, even if you have a large lump sum from the government.
- Go On a Shopping Spree - I do think that spending some money on yourself is a good thing, but you should never waste an entire lump sum of money on a large shopping spree. That money if used for a shopping has been thrown into objects as opposed to setting yourself up for financial success.
- Buying a Brand New Phone - Do you really need the latest and greatest phone? You really don't need this phone. If you want a new phone, then you should buy it out of your salary or monthly income. If you have to wait until a tax refund to buy a new phone, then you probably can't afford the phone.
There are lots of other ways that we could spend our tax refunds, but I didn't want to bore you with a long list. You can make a decision about your specific item based on whether it would be smart financially by comparing it to the two lists above. Most this things fall into either category. Some good news was reported by Bloomberg Business recently. They completed a study of 7000 people and asked them how they would spend their tax refund. The study found that 50% percent of the people are going to save or invest their tax refund and 35% are planning to spend their refund on paying off debt. Based on this study, it looks like more people are seeing the importance in getting out of debt and investing.
The study also showed that about 11% of people use their refunds for vacation money. I actually don't see anything wrong with this as long as your are out of debt and are saving monthly for retirement. If you meet all of those factors, then I believe that using the tax refund for vacation money is perfectly fine, because we all need to enjoy life.
The whole goal of my website is to help people make smart decisions with their money and I want you to think about all the different possible ways that you could spend your money. I am a big proponent of looking into the future before you spend your money. So, all I ask is that you take the time to think about where you spend your tax refund. Make the best choice possible for your financial future.