What to do with your tax refund

This year you’ve got a little extra time to file your federal tax return (until May 17th) which means you’ve got a little more time to decide what to do with a tax refund. For many Americans, filing their returns means a tax refund. That can be a nice surprise but for others it is money they are counting on to pay bills or debts. If you are in the lucky position to be receiving a refund this year, it could also be an important opportunity to improve your personal finances. 

When I started researching and writing this article, I feared that I would learn that most people spend their return. I’ve certainly talked to a few friends and neighbors who have done just that. Fortunately, most people spend it wisely. In a 2020 survey of US adults[1], most taxpayers planned to put their refund towards savings. While the global pandemic of the last 14 months has changed the personal finances of many, this pre-pandemic trend is a good sign. Saving means that you want options and that you don’t want to be caught in a tight spot if there is a downturn in your finances. 

Paying down debt was the second most frequently cited choice at 34% of Americans. By paying down debt, you can free up cash flow which can allow you to save more for the future. 

Nearly one in four Americans use their refund to cover everyday expenses. This can happen occasionally but if it is your regular pattern with your refunds, you may be fooling yourself into believing that you are saving. 

While you may have heard about a friend or neighbor who spent their refund on a brand-new Ford Mustang Mach-E, it is actually not very common. As a financial planner, it’s good to see that people are generally responsible with their tax refunds. 

What should you do with your refund? Here are my top six: 

1. Replenish or top-off your Emergency fund
2. Put some towards next year’s return (a form of forced savings) 
3. Fund your (and your spouse’s) IRAs[2] 
4. Fund your son or daughter’s Roth IRA
5. Start a new goal-based savings fund, e.g., home renovation, second home, funds for business start up
6. Use the funds to hire an attorney to create/update your estate planning documents

Want to know about why these are my favorite tax refund uses? Give me a call. We’re here to help. 

Lyman H. Jackson

Lyman@PlanWithFPS.com

617-653-3303

Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.

[1] Survey of 7,671 U.S. adults conducted by the National Retail Federation and Prosper Insights & Analytics as published on GoBankingRates.com, May 20, 2020. https://www.gobankingrates.com/taxes/refunds/what-americans-do-with-tax-refund/

[2] Every taxpayer can fund an IRA regardless of income as long as you have earnings from work.