Tax time—that interesting time of year when ordinarily smart people begin to make really dumb financial decisions. Isn’t it amazing to watch what a little extra cash (otherwise known as a tax refund) lining the pockets can do?
Last year, the U.S. federal government paid out $260.9 billion in tax refunds, at an average of $2,725 per refund. And 61% of taxpayers expect that this year, they’ll receive some sort of refund on their returns. While there are many dumb ways to spend it, here are my top five:
Act like it’s FREE money
The operative word in the term “tax refund” is REFUND! Common synonyms for refund are “repayment,” “reimbursement,” and “return of overpayment.” Tax refunds are not free money. The government is not giving you a bonus every year just to thank you for so awesome.
This is money that you’ve allowed them to borrow from you all year long. And now, unlike most of your friends or family members, they are actually paying you back.
Never mind the fact that you made the loan with NO interest even though you pay them back with interest on your student loans or credit card accounts. Do you really have enough money to lend some to anyone, let alone the government, under those terms?
If you routinely get a big tax refund, change your withholding (use this calculator to determine the amount you should be having withheld along with instructions on how to change it). Your goal is to neither owe or to be owed at the end of the year. If you can come within $100 of that goal, you’re golden.
Pay down debt
Before you do that—noble as it may be—you need an emergency fund. If you are not able to fund your own future emergencies, you’ll never get out of debt because you will keep running back to the credit cards for a bailout.
Keep making your regular debt payments and use the refund to establish your Emergency Fund. Then keep adding to it until you reach your goal (enough to live for at least three months without a paycheck, or say $10,000). Now you’ll be in a beautiful position to rapidly pay down your debt and have confidence that you’ll still keep going when life happens.
Make a down payment
On a car, television, furniture or any other thing that will turn into new monthly payments—also known as debt.
The burning sensation and feeling of prosperity and richness strong arms people into putting money down on a new car, boat, Disney vacation or what have you. Here’s the thing to remember: After that down payment, you’re still responsible for the pesky monthly payments that stick around much longer.
Even though you’re feeling good right now, remember a tax-refund comes but once a year. The joy of getting back your tax overpayment can quickly turn into a nightmare if you’re not careful.
Assuming you are prepared for emergencies, use the refund to abolish your bills, not create new ones. Never create on-going debt with one-time funds.
Indulge in a little retail therapy
There’s no doubt that shopping for new clothes, shoes, electronics or other cool stuff is a great anti-depressant, but it’s dumb. Once that shopper’s high wears off you’ll be right back where you were—broke but with more stuff.
Go for a brisk walk, spend time—not money—with your kids, friends, and family doing things that won’t cost money. Most every city has a big museum or zoo that’s free on one day each month. Or go on a picnic, take a bike ride, explore your own city by googling the name of your city plus “free attractions” to find all kinds of things to do for free. You’ll be amazed. And you’ll feel a lot better, too.
Cram it under the mattress
It’s an idea, but not a very good one. Money under the mattress is not earning any interest, it’s vulnerable to theft and fire—but most of all it’s vulnerable to you in a weak moment.
If you do lose your job or have a true financial emergency, you’ll be plenty glad you got smart with this year’s tax refund.