07 Apr 2017 Six Ways to Use Your Tax Refund

Though I haven’t worked on tax returns that aren’t mine in quite some time, there is a very real part of my CPA brain that can’t help thinking a lot about taxes this time of year. And one of the things I think about is tax refunds, and how the people who get them choose to use them.

Now, there’s a certain school of thought which scoffs at the idea of getting tax refunds, because it’s an “interest-free loan to the government” and so forth, generally followed by some joke about the ineptitude of the government as a borrower of your hard-earned money. But, while I understand that school of thought and might even subscribe to one of its lighter versions, the reality is that many (if not most) people, if they were to adjust their withholding such that they wouldn’t receive a refund, may not make the decisions required to put their extra take-home pay to good use. So the refund, for many folks, is a sort of built-in way to automate a small savings program.

With that commentary out of the way, the question I want to tackle today is, if you do get a refund, What’s the best way to use it? And while there is no single best way, hopefully these six suggestions will get you started in the right direction.

1. You could use your refund to buy cool stuff. Boom. What a way to start this list off. But isn’t that terribly irresponsible of me as a financial planner? Maybe, but not necessarily. What if you’ve determined with your financial planner that you’re saving plenty of money for future goals, and that saving an extra grand or two isn’t really going to move the needle much in the plan’s confidence? Well, in that case, I say take a look at your life and see if there’s something that you would really value, that you would use for a long time, and that you might not otherwise buy out of your regular cash flow. I would say look especially at services or things that might replace tasks you really despise or tools that don’t work well. Maybe you pay someone to mow your yard in the spring and summer months when it feels like you spend six hours a week doing it. Or maybe you bake a lot and it makes sense to get a double oven. Whatever it is, research shows that while money has limited means to buy you happiness, it can buy some measure of it when used to help us spend less time doing things we don’t like and more time doing things we care about most. The caution here is that using your refund to impulse buy a bunch of stuff you don’t need is definitely NOT going to make you happy for very long at all, and so I think that’s not a good idea. But you probably know that…
2. You could use your refund to more fully fund your emergency account. Not having an emergency account is one of the gravest mistakes people with means make with their money. Not everyone has this luxury, but for those of us that have enough income to set aside somewhere in the neighborhood of 3-6 months expenses in cash for some unforeseen emergency, it’s incumbent upon us to do so. Your tax refund could be used to get you there more quickly than you might otherwise, and that’s a great answer. (As an aside, it probably makes sense to look for a higher earning savings account to store this money. Online banks like Ally who have a fraction of the operating costs of the Wells Fargos and Bank of Americas of the world are able to pay a much higher interest rate on their savings accounts). The caution here is it is possible to have too much cash on hand insofar as it dilutes the long-term growth of your wealth. There’s no bright-line test here; just something to be careful of and to talk to your financial planner about.
3. You could use your refund to make a home improvement. I know several people who use their tax refund as their annual “home project” money to make improvements (and add value) to their houses. I’m all for this, because for many people their home is either their largest or second largest asset in terms of value, and it makes sense to take care of our assets. Maybe it’s giving your kitchen an upgrade, or the bathroom a facelift, or putting a new HVAC system in, or having a new roof installed. These are all great things, some of which function primarily to help you sleep better at night (HVAC, roof, etc.), and some of which function to make your home more fun and comfortable to live in and therefore more likely to stay in long-term (kitchen, bathroom, etc.). The caution here is to make sure you balance home improvements with the need to pay attention to your retirement savings.
4. You could use your refund to pay a good estate attorney to set up your will and other estate documents. Quite simply, this is one of the most important investments you will ever make: to pay a good attorney for her time up front to set these documents up, and to update them as you have children or change your mind about how you want dependents cared for, etc. This is one of those exercises we tend to put off because it doesn’t feel urgent, but we put it off at great risk to the people we love most. If something happens to you without proper legal planning in place, you are placing a great administrative and financial burden on your survivors on top of the burden they will be dealing with in having lost a loved one. The caution here is simply to make sure you get some good recommendations on great attorneys in town.
5. You could use your refund to pay your future self. The first item in this list assumed that if you’re saving enough already, you might wisely use your refund to buy something nice and useful. But if you can’t think of anything like that, anything that really will make a meaningful difference in the quality of your life, why not pay your future self and invest that refund for long-term growth? Or, even if you can think of something you might buy that would fit that criteria, you might still decide you value paying your future self more. This could be especially impactful for the younger folks reading this, as you are able to leverage the great asset of Time to grow what may seem like a meager investment into something much larger. Stick it into a Roth (if you haven’t phased out of your ability to do so based on your household income) or a taxable account that will give preferential long-term capital gains rates, and make sure your investments are efficient and diversified. The caution here is to be careful about time horizons–if you’re saving for something specific in the next 5-7 years or so, investing heavily in equities might not be the best way to save your refund.
6. You could use your refund to give away. I wrote earlier about how money can make you happier if you use it to do less of the activities you hate doing and more of the activities you love and value, but do you know what else has a huge impact on your happiness (and even more importantly, that deeper, more profound thing: Joy)? It’s giving. When you give money away, to friends and family, to non-profits and churches, to random people—there is incalculable value in that activity, not only to those who receive the gift, but to you the giver, and in some strange way, the world at large. The caution here is that giving is contagious, and you might find the more you do of it, the less you use the word “need.”

These are just some of the many ways you might put your tax refund to good use (you could also use it to pay off credit cards, or pay down your mortgage, or pay for career-furthering education), and indeed you may use any combination of all of these things. The key is simply to take the time with your family to think through how you might spend that money, doing the best you can to balance your current happiness with your future happiness. And if you ever want a second opinion about your decision, you know where to reach us.