Smart Ways to Take Advantage of Your Tax Refund

Author: Teresa Mears

Tax season is a time of stress for many, but it can be a joyful time for the roughly 75 percent of Americans who receive income tax refunds.

While the refund really means you’re getting back money you loaned to the government at no interest, in practical terms it often means an unexpected infusion of cash into your wallet or bank account. Last year’s average income tax refund was $2,755, according to the Internal Revenue Service. That’s a nice chunk of change.

It’s a great problem to have: What do you do with your windfall?

The best choice for one person may not be the best choice for another. But experts agree on one thing: If you have debt, apply your refund to paying it off, whether it’s credit card debt, student loan debt or other consumer debt. “People should still be focusing first on paying down debt,” says Meisa Bonelli, a Wall Street finance and tax professional whose Millennial Tax company advises entrepreneurs on business and tax strategy.

Debt, particularly student loan debt, should be a primary target because it limits financial options, preventing people from doing what they want with their money, whether it’s buying a house, buying a car or taking a vacation. “Get that debt gone,” she says. “It holds you back from everything else you want to do in life.”

Eric Rosenberg, a financial analyst who writes the blog Narrow Bridge Finance, agrees. “The No. 1 thing anyone should do with a tax refund is pay down debt,” he says. After he left graduate school with $40,000 in student loan debt, he focused on aggressively paying it off. Using all his tax refunds and bonuses, he made the final payment just two years and six days after his graduation.

With his student loan debt cleared away, he began saving his tax refunds, with the goal of buying a home. He didn’t apply any of his refund money to splurges; instead, he saved for fun and vacation with his regular income. The refunds were earmarked for bigger things.

“I treated it like it was extra money that I didn’t need to live on,” Rosenberg says. “I always encourage people to think long term, not short term.”

Others believe that giving yourself license to splurge with part of your refund helps you save the rest. Stephanie Halligan, a financial consultant and blogger, signs a contract with herself before she does her taxes, allocating 50 percent of her refund to student loans and 25 percent to long-term savings. She can spend the remaining 25 percent on whatever she wants.

“It’s easy to react on impulse and emotion when your refund hits, so prepare now for what you’ll do with that moolah later,” she advises on her personal finance website, The Empowered Dollar.  If you’re getting a big refund, a check in the ballpark of $1,000 or more for taxpayers who don’t have a side business, consider adjusting your withholding so that you’ll have that money available to you during the year. But those who don’t have substantial savings want to avoid a scenario in which they owe four figures to the IRS at tax time.

“I think people should withhold the maximum they can withhold,” Bonelli says. Rosenberg concurs. As his businesses, running Narrow Bridge Finance and building websites, have grown, his refunds have shrunk. Last year he had to pay the IRS.

Here are the seven smartest things you can do with your refund:

Pay down debt.

If you have any consumer debt, student loans, credit card balances or installment loans, pay those off before using your refund for any other purpose. Car payments and home mortgages aren’t in this category, but you can consider paying extra principal.

Add to your savings.

“You can never save enough,” Bonelli says. You can use the money to build up your emergency fund, your kids’ college funds or put it toward a specific goal, such as buying a house or a car or financing a big vacation.

Add to your retirement accounts.

If you put $2,500 from this year’s tax refund into an IRA, it would grow to $8,500 in 25 years, even at a modest 5 percent rate of return, TurboTax calculates. If you saved $2,500 every year for 25 years, you’d end up with more than $130,000 at that same 5 percent rate of return.

Invest in yourself.

This could mean taking a class in investing, studying something that interests you or even taking a big trip. “Do something that enriches yourself or adds value to your life,” Bonelli says. She is planning to take a class in art therapy this year using money from her refund.

Improve your home.

Consider putting your refund to good use by adding insulation, replacing old windows and doors or other improvements that would save energy, and therefore money. Or perhaps it’s time to remodel your bathroom or kitchen. You’re adding value to your home at the same time you’re improving your living experience.

Apply your refund toward next year’s taxes.

This is common among self-employed taxpayers, who are required to pay quarterly taxes since they don’t have taxes withheld. By applying any overpayment toward upcoming tax payments, you can free up other cash.

Splurge on something you’ve always wanted to do.

If you’re out of debt and have substantial savings, this may be the time to take the trip to Antarctica or Australia that you’ve always dreamed of taking. Such an experience can be life-changing, and you never know what impact it will have on your future until you actually do it.

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This article originally appeared at http://www.dailyfinance.com/2014/03/31/smart-tax-refund-strategies/; reprinted by permission.

Jefferson’s First Principle of Association

Originally Published in Flourishing July/August 2010

“To take from one, because it is thought his own industry and that of his fathers has acquired too much, in order to spare to others, who, or whose fathers, have not exercised equal industry and skill, is to violate arbitrarily the first principle of association, the guarantee to everyone the free exercise of his industry and the fruits acquired by it.”  

—Thomas Jefferson, letter to Joseph Milligan, April 6, 1816.

Larry Summers served briefly as a Secretary of the Treasury under President Clinton, and later as President of Harvard University, where he got into trouble for inadvertently hinting that boys might have a greater natural aptitude for math and science than girls. He is now a key, behind-the-scenes economic advisor to President Obama, having lost out to Tim Geithner as Obama’s Treasury Secretary.

In a New York Times article, The Return of Larry Summers, published on November 26, 2008, David Leonhardt told his readers about one of Summers’ favorite economic arguments: Require every household in the top 1% of American income earners, who as a group have an average annual income of $1.7 million, to write a check for $800,000. This money could then be pooled and used to mail a $10,000 check to every household in the bottom 80 percent of income distribution, those making less than $120,0001.

Leonhardt’s story may only be symbolic, but it is instructive. I see several problems with Summers’ idea.

First is the fact that the $1.7 million is an average. Many households earning less than $500,000 are also in the top 1%. The threshold income to be in the top 1% was $410,096 in 2007, the latest year for which data is available2. Their tax rate would not be the roughly 47% envisioned by Mr. Summers; it would approach 195%. (It’s an important fact, too, that the makeup of the top 1% is constantly changing, as people with new ideas and special talents migrate from the lowest levels of income distribution to the top.)

Second, I believe that Mr. Summers is advocating government-sponsored armed robbery on a heroic scale. I suspect that many among the top 1% might resist having their earnings from whatever source – intellectual and artistic endeavors, business interests, professional practices, or investment, for example – snatched so imperiously. After all, does Summers’ proposal differ in any basic respect from private citizens taking the matter of income inequality into their own hands? It’s probably true that rich people won’t draw their six-shooters to defend their income from the government, but they might well vote with their feet. Talent and Capital tend to reside where they’re treated best.

Third, it’s widely known that Warren Buffett, the world’s third richest man, is very conservative in his personal spending habits, as was Sam Walton, the founder of Walmart.3 Those two may be exceptions of a sort, but the few hundred mansions, yachts, and airplanes belonging to others among the top 1% pale into insignificance alongside the total consumption of the general population. Moreover, a significant portion of the consumption of the wealthy, who are so often demonized as greedy fat-cats, takes the form of support for universities, hospitals, research facilities, theater and music companies, museums, libraries, and churches; to name just a few of their non-profit pursuits.4

Finally, contrary to the myth of conspicuous consumption, most of the wealth owned by the top 1% is held in the form of business, financial, and industrial assets.5 The wealthy and their productive capital can serve consumers throughout the world by producing a vast array of goods and services, or by financing that production, or by paying the wages, salaries, and benefits of a substantial percentage of America’s workforce. The intended beneficiaries of Summers’ scheme should already enjoy a magnificent range of benefits derived from the savings and investments of all Americans, including the invested wealth of those at the top.

I believe that widespread understanding of this issue is critical for America’s return to lasting prosperity; and that economists like Larry Summers and politicians like Barack Obama simply do not appreciate (or care?) that their redistribution policies may limit the formation of productive capital and the creation of well-paying, private-sector jobs. The history of forced wealth and income redistribution is replete with examples.6

In my opinion, Summers’ favorite economic argument does not really benefit the bottom 80%. Rather, forced redistribution of wealth and income consumes the savings and capital of America’s most productive citizens, or drives it and them offshore. My reading of history indicates that such policies have no lasting beneficiaries, only victims. And, most importantly, I believe Thomas Jefferson observed correctly that the forced redistribution of wealth and income is a first-order violation of human rights. mh

1 http://georgereismansblog.blogspot.com/.

2 http://www.ntu.org/tax-basics/who-pays-income-taxes.html.

3The World’s Billionaires, Forbes Fact and Comment, March 10, 2010. 

All the Money In the World, Peter Bernstein (editor), Knopf, 2007.

4 Caroline Bermudez, “Wealthy Are Making Bigger Gifts to Charitable Causes”, Chronicle of Philanthropy, July 1, 2010. (http://philanthropy.com/article/Wealthy-Are-Making-Bigger/66112/).

5http://sociology.ucsc.edu/whorulesamerica/power/wealth.html

6 The Ascent of Money: A Financial History of the World, Niall Ferguson, Penguin, 2009.