Smart Ways to Use a Tax Refund

As of May 2nd, over 135 million tax returns had been filed with the IRS. Nearly 100 million of these filers will receive some sort of refund from the government with the average refund topping in at $2,696. So what should Americans do with all of this newfound dough?

If you’re smart, you’ll first give yourself an instant raise by adjusting the amount of income tax that is withheld from your paycheck each payday. You can do this by completing a new Form W-4 (You can find a blank one in PaycheckCity Payroll Resources. ) By withholding a little less each payday, you’ll receive a little more in your take home pay. Ideally, at the end of the year, your tax liability will match the amount you withheld. The ultimate goal would be that no money exchanges hands come tax time. But let’s admit it. There is a psychological element to receiving a refund from the IRS. It’s a thrill to receive “found money” akin to that $20 you stuffed in your back pocket the last time you wore your jeans. So if you find yourself in that boat, here are some recommendations from our resident tax expert, Sam Kerch.

1. Pay off debt

Paying down a credit card balance that is earning interest at 15% is like earning 15% on an investment—an incredibly valuable use of your money. While making the monthly payments on a credit card may seem fine, overtime the money you spend on interest from your credit card could climb to multiple what your original items purchased were worth. When you have some extra money on hand, it is always a wise investment to pay down your debt.

2. Contribute to your emergency fund

An emergency fund that can cover you and your family in the event of a job loss or health issue is crucial to financial preparedness. Typically an emergency fund should cover three to six months worth of your fixed expenses such as mortgage, utilities, and food. No matter what the size of your refund, starting an emergency fund will put you ahead in the long run>

3. Contribute to your retirement fund

According to a 2012 report from the Center for Retirement Research, 'at Social Security's earliest retirement age of 62, only about 30 percent of households are prepared for retirement.” Consider this statistic knowing that most Americans also expect to have a higher standard of living when they retire than they do now! Putting away money for your nest egg is a good use of that tax refund check.

4. Invest in additional education

Wanting to finally finish that degree? Investing in your education that can put you on a path to higher lifetime earnings can be a short-term move with long-term benefits.

5. Spend it on special projects such as home improvement

The key here is to spend the tax refund on projects that are likely to increase the value of your home. Kerch advises to never put a tax refund towards a vacation or use it as disposable income in general.

So how do you end up with a large refund in the first place? It’s because your tax payments (typically withheld from your paycheck throughout the year) are greater than your tax liability. Your tax liability is the amount you actually owe found on line 63 of the 1040 tax return form. If you manage your tax withholding from your paycheck correctly, your refund will be small, or you may pay a little extra in taxes when you file. This way, you have more take home pay throughout the year and can either invest the difference or pay off your bills a little earlier than you thought you could. People view tax refunds as found money, but in reality a big refund is an interest-free loan to the government. You pay penalties when you underpay, but get nothing if you overpay. So what will it be for 2014? Big tax refund or more take home pay throughout the year?