Visions of excess dance in your head as you await the arrival of a tax refund check from the Internal Revenue Service (IRS). This is “found money,” so you might as well spend it on something frivolous, right?
Not so fast! Tempting as it may be to use a tax refund for a shopping spree or an expensive night on the town, the smart move, say financial planning professionals, is to do something practical with at least part of it, while reserving the rest to spend on something fun.
Here are some of the best options for putting a tax refund to constructive use:
- Put it toward retirement. Instead of instant gratification, think long-term by putting the money in a retirement plan. Put the money in a Roth Individual Retirement Account (Roth IRA) or a traditional IRA, where it has an opportunity to grow over time tax-deferred or (with a Roth) tax-free, subject to IRA rules. Ask a financial planner if you need help evaluating, choosing and establishing a retirement account to house the money.
- Use it to pay down a high-interest debt. Debt can mount quickly, especially on a high-interest credit card. Using a tax refund now to help get out from under a burdensome, fast-growing credit card balance will translate into greater financial freedom later.
- Make a vacation allocation. You know what they say about, “All work and no play…” Deposit your tax refund into a Certificate of Deposit (CD) or some other type of low-risk savings vehicle and earmark that money specifically to fund a fun vacation. If you put it in a CD, be sure it has a short enough term that you can take that money out penalty-free in time to use it for your vacation.
- Strive for refund reduction. While it’s gratifying having the IRS send you money instead of vice-versa, the fact that you’re receiving a refund in the first place means you had too much tax withheld — which amounts to an interest-free loan to the U.S. government. “The bottom line is that you don’t want a big refund,” said FPA member Jon L. Ten Haagen, CFP®, of Huntington, NY. “Try to keep it under $500.”
To get below that threshold, talk to a financial planner and your employer about ways to adjust your tax deductions, so you retain control of your money instead of Uncle Sam.