This time of year means one thing for a lot of families and individuals: getting a large tax refund. Receiving a hefty tax refund can be a nice surprise and a good way to help supplement a strained budget.
The IRS reports it issued 97 million refunds for the 2016 tax year, with the average refund being just under $2,800. Receiving a four-digit refund can be a significant windfall. Many taxpayers plan to save a majority of their refund, but that isn’t always the case. If you received a large tax refund this year and are wondering how to spend it, here are five ways to avoid.
1. Take it to the casino.
A tax refund is often considered found money. If you weren’t expecting to have a large amount of money and suddenly it falls into your lap, it might be tempting to take the money and run to the casino to see if you can turn it into a larger amount.
“However tempting it may be, steer clear of the casino with your tax refund check,” says Oliver Lee, financial planner and founder of The Strategic Planning Group. “You’re more likely to lose the refund at the casino than turn a profit, and taking that chance isn’t worth it.”
While the desire to grow your tax refund into a larger amount is understandable, there are other, safer ways to do it.
2. Go on a shopping spree.
Marketers like to play on the emotion of taking “free money” and spending it on something fun. There’s nothing necessarily wrong with that, but when you have competing needs, it can often lead to a worse financial situation — especially if you spend the entire amount on something flashy.
“Spending that ‘free money’ on an even bigger TV or that Louis Vuitton bag will feel great for a few weeks, maybe even a month,” says Eric Black, financial coach and founder of Financial Freedom Mentors. “Then you have 11 more months of financial stress until next year, when you hope to get another refund.”
That doesn’t mean you shouldn’t spend any of your refund on something fun. Black suggests snagging 10%-15% of your refund for a fun purchase and applying the rest to other needs.
3. “Invest” it in a depreciating asset.
Have you had your eye on a particular truck or boat? You might be tempted to “invest” your tax refund in purchasing it. But like the shopping spree above, this kind of short-term high can easily turn into a long-term budgetary pain.
Before deciding to plunge your tax refund into a car or boat, consider your entire financial picture. Do you have the money you need to pay for taxes, insurance and upkeep on said truck or boat? If not, it’s often best to look for other investments.
4. Go on vacation.
Taking a vacation is expensive — especially when you have a growing family — and a tax refund of several thousand dollars might make a vacation possible. But if, like most of America’s workers, you’re in debt, lack an emergency fund or are behind in other financial responsibilities, blowing your tax refund on a trip may not be the wisest use of your money.
As Black suggested earlier, take 10%-15% of your refund and use it for a trip. This allows you to still have money for a vacation without feeling like you wasted an opportunity.
5. Borrow against it.
Did you know you can borrow against your tax refund? These used to be known as refund anticipation loans but were squashed by regulators. Unfortunately, similar offers are still available at many tax preparers.
Not only are such arrangements fee-heavy, they put you at risk if your refund isn’t as much as anticipated. These loans are typically aimed at those who need the funds most desperately, so it can be difficult to avoid succumbing to marketing ploys. If you need funds, there are other, far cheaper ways to make money that don’t involve a loan.
How to spend your tax refund
Now that you know some of the landmines to avoid, take a look at your total financial picture to decide how to use a large cash windfall.
“Whenever possible, pay down debt,” Lee advises. “Paying down credit card balances is always the number one thing to do with any extra funds. After that, money should be put into a retirement fund.”
Then, ask yourself these questions:
• Do you have an emergency fund of at least $1,000?
• Are you behind on any bills?
• Is there something you need to advance your career?
• Are you saving for a large expense?
Thinking about these questions will help you determine how to best spend your tax refund. You can still use part of it on something fun, but make sure you put the funds to good use.
Getting a tax refund can be exciting, especially if you weren’t expecting a large amount. By using it wisely, you can put yourself in better financial standing now and the rest of the year.