Your tax refund isn’t a bonus
During tax season, many people patiently await their tax refund so they can pocket extra cash. However, it’s crucial to remember that a tax refund is part of your earned income that has been withheld from each paycheck by the IRS as income tax. When it’s time to file returns, some individuals receive a refund because the government withheld more in taxes than the individual needed to pay.
It’s important that taxpayers not look at a refund as a “bonus,” and instead employ a few strategies that can maximize the funds and put that money to good use. Below are a few do’s and don’ts to consider:
- Do: Create an emergency fund. If you don’t have accessible assets in the event of an emergency, build a cushion to relieve stress if an unexpected large expense crops up like medical bills or a car repair.
- Don’t: Splurge on a luxury purchase because you now have this lump sum of money that was unexpected in your monthly budget.
- Do: Pay off credit card debt or other expensive debt with a high interest rates. Mortgages, car payments and student loans are often regarded as ‘good debt,’ so it’s OK to have this type of debt as long as you are able to make your monthly payments.
- Don’t: Take an expensive vacation that wasn’t already factored into your financial plan.
- Do: Begin investing some of the excess money in a diversified portfolio. If you don’t have any expensive debt, consider starting an investment account to make your refund work harder for you.
If you have a significant tax refund each year, reconsider your tax filing strategy and consult with your financial and tax advisor. Paying excess taxes during the year is essentially a free loan to the government until you file and receive your refund. If the IRS is withholding too much, there may be ways to decrease your withholdings and have more of your income in your regular paycheck.