It’s that time of year again – tax time. We’ve put together 25 things to consider regarding your tax refund so you can make more informed decisions. Some people get excited at the chance of receiving a refund, on the other hand others may get stressed about owing Uncle Sam. If this is you, think about optimizing your tax strategy. You shouldn’t be receiving a refund OR owing the government. This means that you’re receiving too much or too little in your paycheck.
If you do happen to receive a large refund, don’t freak out! There are many ways that you can plan to use the money to strengthen your financial goals, and your path to FIRE.
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1. Your Tax Refund is not “free money” or a bonus payment
You’ve received a tax refund because you paid the government too much money over the previous year. In 2018 the average tax refund was $2,035. Alternatively imagine what you could’ve used that extra $169.59 each month towards instead.
2. You did NOT win the lottery, so don’t act that way
Now is not the time to splurge on an unnecessary gadget or new toy you think you “need to have.” Continue reading to understand how you should be handling your tax refund and how to adjust for the current year. Einstein said “The definition of insanity is doing the same thing over and over again, but expecting different results.” Please don’t be insane, start planning appropriately.
3. You shouldn’t want a tax refund in the first place
Yes, you read that right – you should not want a tax refund. When you get a tax refund, you essentially are getting paid back without interest from the government for the loan you’ve been giving them for the past year.
4. You shouldn’t rely on your tax refund
Many people do, so you’re not alone. However, you should work on adjusting your W-4 withholdings so you see more money in your paychecks throughout the year. If you struggle planning ahead for large purchases or vacations, check out our Budgeting Page.
5. Learn how to stop getting such a large tax refund
- First grab the previous year’s IRS Form 1040 (your tax refund paperwork) and your most recent pay stub.
- Use the IRS W-4 Form and the worksheet found there to determine how many allowances you should be claiming.
- Also check out the IRS Withholdings Calculator, which asks a series of basic questions to help determine the right amount of withholdings for your situation.
Things You Should Do With Your Tax Refund
6. Set up or add to your emergency fund
Having an emergency fund is one of the best ways to separate yourself from financial turmoil. Things will indeed pop up unexpectedly and you need to be prepared for when they do. Establishing an emergency fund prevents you from needing to take on additional debts that slow down your financial progress dramatically. Read our article on why everyone needs an emergency fund.
7. Pay off higher-interest debts
Reducing or eliminating any high interest debt you have will help free up room in your monthly budget. These debts would include title loans, payday loans, debt consolidation loans, credit cards, car loans or high-interest rate student loans.
8. Save for known upcoming expenses
Begin to better prepare yourself for your upcoming expenses. Consider filling up some of your sinking funds, particularly those that you know will be paying soon. A few categories to consider:
- Car Repairs
- Insurance Premiums
- Home Repairs/Maintenance
- Membership Renewals
- New Home Purchase
9. Invest in your IRA
If you don’t have one already setup, open one! Check out our investing basics page to understand deduction eligibility, contribution limits and to learn more about investing.
10. Invest in a 529
If you have children, or are planning to have children ,contribute to a 529 plan. Not only are you helping set up your children’s future, you’ll also receive some tax benefits depending on which state you live in. See which states have a deduction at finaid.org
11. Invest in a taxable-brokerage account
While this does not offer tax benefits, it’s still a good way for you to save for your goals and earn some growth on your investments.
12. Pay down your mortgage
Already completed everything else on this list? Way to go! Paying down your mortgage will eventually allow you to invest that money instead. You’re well on your way to financial independence.
13. Will / Estate Planning
Not only will you be protecting your family and your assets, you’ll also get to control where your assets go when it’s time to pass things on. The price you’ll pay for will and estate preparation depends on the complexity of your needs, not to mention establishing a plan will give you peace of mind.
14. Financial planning session
Want professional advice? Consider hiring a one-time fee based advisor or CFP to help you review your current retirement plan. Read What to Expect from a First Meeting With a Financial Planner to better understand how they can help you improve your financial outlook.
15. Home Renovations
Spend some money on improving your home. A fresh coat of paint, upgrading appliances, new furniture or even some new carpets can make your home a more enjoyable place to live and keep you satisfied with what you have.
16. Upgrade your wardrobe
Need some new work pants or have some holey socks? Give yourself a needed replacement or upgrade. Just don’t spend frivolously when you go clothes shopping and come home with stuff you don’t actually need.
17. Start or grow your business
Work on establishing a passive income stream! Find your passion and go for it, check out a list of 50 businesses you can start for under $5,000
18. Enjoy a date night
Hire a sitter and enjoy yourself for a night. A small splurge never hurt anyone, as long as you’re meeting your other goals.
19. Hobbies & Toys
Already crushing your financial goals across the board? You’ve earned the ability to have some play money. Try your hand at a new hobby or buy something that’s been on your want list for awhile.
20. Enjoy a hard earned vacation
Once you’ve fully satisfied your other financial goals, it’s time to kick back and relax.
Things You Should Not Do With Your Tax Refund
21. Buy useless material things that you don’t need
This is what most people get hung up on. They think they’ve struck gold when they receive a large tax refund and just go on a spending spree. There are so many better ways to put your money to good use. Maybe this was you in the past, but not anymore!
Terrible strategy at attempting to gain wealth, please don’t do this.
23. Let it sit unplanned in your checking account
Give every dollar a plan in your budget. Otherwise you may be more tempted to spend it aimlessly, or let is sit there where it won’t earn enough interest to keep up with inflation.
24. Upgrade cars for no reason
So many car advertisements prowl on people at tax time. Don’t fall victim to their game. You don’t need a new car. You want one. Stay focused on the big picture.
25. Take a vacation
If you’re not already killing your financial game you aren’t ready to start putting money towards vacation splurges. Focus on strengthening your finances.
- You should work towards reducing or eliminating your tax refund
- With all the extra money in your paycheck, consider increasing your 401k contribution