It’s nearly the official tax deadline, which means you will soon have your tax refund in hand.
A tax refund can be a nice boost to your savings or debt payoff, and it can even pay for a little fun. Whatever you decide to do with your refund, it’s important that you make a plan for that money. Otherwise, you could end up using it to fund random purchases you’ll regret down the road.
Keep these points in mind when your money fund arrives to avoid common tax refund mistakes:
Tax Refund Mistakes: A Large Tax Refund is not the Goal
It’s exciting to feel like you’ve received free money in the form of a substantial tax refund, but that’s really not a good thing. The smaller your refund, the better.
Why? Because it means that you received that cash throughout the year instead, and may have put it to better use. According to this survey, 29% of Americans planned to spend last year’s return on things like food and bills, while 27% wanted to use it to pay off debt.
However, people could use that money to beef up their savings or pay off debt throughout the year, which would save them money in interest payments. You could even allocate that money to your retirement account each month instead, which would give it more time to earn interest.
Giving too much to Uncle Sam during the year is one of the biggest tax refund mistakes. If you find that your refund is too large, try adjusting your withholding this year. The ideal refund amount is as close to $0 as possible because it means you paid the government the right amount throughout the year.
Invest Your Refund Well
Many Americans do plan to invest their tax refund, which is smart. However, the type of investment you choose does matter.
Here are some do’s and don’ts of where to invest your refund:
- Pay off high-interest debt
- Prepare for expenses down the road, and add that money to an emergency fund
- Boost your retirement savings
- Contribute to your child’s 529 college savings plan
- Set up an HSA (Health Savings Account)
- Invest in your friend’s business idea if you’ve got other financial areas that need your attention
- Invest in cryptocurrency. There is a lot of uncertainty around cryptocurrency, and investing in it is a big gamble. Plus, switching to different currencies makes you liable for taxes on your earnings next year. There are better ways to invest your refund.
- Turn it into a down payment on a house, car, yacht., etc. If you’ve been saving for a new place or car and your refund will help you pad that down payment, that’s fine. Just don’t confuse a large refund with a raise. It could be tempting to think you can look at costlier homes or buy a more expensive car than you were shopping for originally, but know that those purchases come with fees, upkeep, and taxes that you might not be able to keep up with.
Putting that Money to Work
Keeping your refund in your checking account might not sound like a bad idea. But if you leave it there, it could be squandered away. That’s because money in your checking account is likely to be spent.
Think about it: If you get a $2,000 tax refund and you leave it in your checking account, you might be tempted to spend it on little expenses here and there. You might find that you’ve spent it on clothes, gas, furniture, and activities instead of investing it or paying off debt.
Make a plan for every dollar of your refund. Coming up with a strategy will help you make the most of that money.
About Your Richest Life
At Your Richest Life, Katie Brewer, CFP®, believes you too should have access to financial resources and fee-only financial planning. For more information on the services offered, contact Katie today.