What Should I Do With My Tax Refund?

Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®

The tax filing deadline is bearing down on us, and many Americans are expecting a hefty refund from the IRS. For many, a tax refund is akin to a windfall, to be used to purchase things that are usually difficult to afford – a bigger TV, a piece of jewelry, a computer, whatever it may be. However, before splurging on unnecessary wants, it’s important to determine if perhaps your sudden boon could be better suited elsewhere. In this article, we’ll review some of the most useful places a lump sum of cash can be inserted to help you maintain your financial security and improve your long-term retirement readiness. 

Why A Refund Isn’t a Great Thing

But before we get into that, I’d like to note that having a tax refund isn’t necessarily a good thing. It means you consistently overpaid on your taxes throughout the previous year. Wouldn’t those funds have come in a bit more useful earlier on? For one, they could have helped alleviate any financial concerns you were having. 

Secondly, they could have gone into an investment account earlier, where time in the market is one of the most critical factors. Finally, inflation will have chipped away at your money’s value by the time it’s refunded to you. You likely received a refund because you didn’t have a tax-savvy financial plan in place. Here, a financial professional can help you craft a plan that won’t see you giving Uncle Sam a penny more than he deserves.

But what’s done is done, so let’s look into how to make the most of your refund.

1. Pad Your Emergency Savings

If you don’t have three to six months’ worth of savings safely stashed in a highly liquid position, such as cash in a savings account, you’re placing your financial health at risk in more ways than one. If you’re in sudden need of money and don’t have a reserve to draw from, you may be forced to withdraw from your investment accounts at an inopportune time. Here, you could encounter these issues: 

  • An Early Withdrawal Penalty of 10% (if under 59 ½ ) (Retirement Plan Only)
  • Tax Implications (Both Retirement and Brokerage Accounts)
  • If the markets are down, you could be selling when you should be buying

An early withdrawal with its associated penalties and taxes during a down market may serve as a band-aid for the financial trouble you’ve found yourself in. However, it will likely create more issues down the road.

2. Pay Off High-Interest Debt

Unfortunately, Americans are drowning in bad debt, and the numbers are only increasing. By the end of 2023, Americans possessed a combined total of $1.13 trillion in credit card debt with an average APR of 21.47%

Given the staggering amounts of high-interest debt Americans are in, any windfall should be wisely utilized. 

Rarely will an investment consistently outpace the guaranteed “anti-return” of a high-interest debt product, such as a credit card. You’re not doing yourself any favors by investing or purchasing unnecessary luxury items while your debt grows into a mountain that will take years to get out of. Slicing off a sizeable chunk with your refund will not only reduce your stress levels but also motivate you to continue paying down the rest as fast as possible. 

And hopefully, it will be enough to extinguish your debt entirely.

3. Invest Your Refund

Contribute To An IRA 

Unfortunately, you could have been growing your savings many months earlier had you paid only what you owed from the beginning. However, now is better than never, and an IRA is a great place to start investing. 

As a refund is inherently ‘post-tax,’ you can contribute to a tax-deferred Traditional IRA, though the contribution won’t be deductible. Phase-out deductions won’t apply either due to the post-tax nature of the contribution – there’s nothing to deduct, after all. Alternatively, or in addition to, you can contribute to a Roth IRA, whose contributions grow tax-free. However, income limitations will apply, though a Backdoor Roth could make sense if those limits do apply to you. 

Invest Within a Brokerage Account

If a tax-advantaged retirement account doesn’t make sense (perhaps you’ll need these funds before retirement age), a brokerage account is always an option. These accounts can also be filled with tax-efficient assets such as ETFs.

4. Invest In Yourself

Is your job future-proof? Is technology changing so fast that it’s hard to keep up with? If the answer is no to either of those questions, one investment that may be worth more than any stock could be to reskill and upgrade your existing skills via courses. 

A recent McKinsey Global Institute study shows that by 2030, at least 12 million Americans will be forced to change jobs due to advances in automation and artificial intelligence. However, that number could be much, much higher. If you’re unconvinced, just click here to see what is in store for us.  

Instead of reacting to a sudden layoff, a proactive approach to reskilling may be your best bet for future-proofing your finances and career. 

Additionally, if you feel you’re already falling behind all that’s tech-related, consider taking a course to at least learn what’s already out there and how you can implement these new tools into your current workflow. 

Finally, if you’re already retired, taking an educational or physical education course can help you keep your brain and body sharp and active. Many Americans work hard for their retirement, only to succumb to poor health early on because they don’t take steps to stave off dementia, frailty, and

other age-related conditions. Another course I could strongly recommend is about digital fraud, which is becoming rampant as technology advances at ever-increasing rapid paces. Being aware of these practices is your best first line of defense.

In Conclusion

In an ideal world, you wouldn’t ever receive a refund. Your funds would go exactly where they need to go from day one, whether that be to an emergency fund, savings goals, self-improvement, or any of the other million ways you can spend your hard-earned money. Of course, the world isn’t ideal, and sometimes, a refund can occur regardless of your plans. We can’t control everything all the time, but we can make the best of what’s left over. 

Also, I don’t mean to say that these are the only ways you should spend your refund – I simply emphasize these points from the perspective of a fiduciary financial advisor. Sometimes, splurging on a material good can provide just the mental health boost you need, or perhaps your refund could go to some preemptive house and car maintenance. 

However, if you’d like to make the most out of your money using one of the methods I’ve discussed (besides point number four – regrettably, I don’t offer programming courses or yoga sessions, though I’d be happy to discuss financial fraud prevention strategies), I’d be glad to sit down with you to not only optimize the usage of your refund but also lay out a tax-savvy investment plan that could reduce your chances of a hefty refund next year. Just click the button below to arrange a time. 

Disclosures

Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. All investment strategies have the potential for profit or loss. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author/presenter as of the date of publication and are subject to change and do not constitute personalized investment advice.

A professional advisor should be consulted before implementing any investment strategy. WealthGen Advisors does not represent, warranty, or imply that the services or methods of analysis employed by the Firm can or will predict future results, successfully identify market tops or bottoms, or insulate clients from losses due to market corrections or declines. Investments are subject to market risks and potential loss of principal invested, and all investment strategies likewise have the potential for profit or loss. Past performance is no guarantee of future results.

Please note: While we strive to provide accurate and helpful information, we are not Certified Public Accountants (CPAs). The information in this article is intended for informational and educational purposes only and should not be interpreted as tax advice. It is crucial to consult with a CPA or tax professional to discuss you

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CFP®, AIF®, AWMA®, CRPC®

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