Personal income tax: How to use your refund for financial growth

Many Americans get a tax refund each year. This happens because they paid more in taxes than they actually owed. It might seem odd to pay extra money to the government throughout the year, but when tax refund season arrives, many people look forward to getting that money back, as if it's a gift.

Here are four basic options for your refund.

1. Don't receive a refund.

There are plenty of psychological reasons why we withhold too much. Think "out of sight, out of mind." And a lot of us use mental accounting when we anticipate the "gift" of a refund and assign a category for what we'll do with it. Nevertheless, you may want to adjust your estimated withholding so the total amount held from your paycheck equals close to what you'll owe at the end of the year. You may end up with a smaller refund or owe some tax, but you'll increase your take-home pay throughout the year.

Pro: Psychology aside, minimizing your withholdings means you'll receive more in your paycheck each month, which may help with your overall budgeting.

Con: Sorry, no present for you when refund season rolls around. You may end up writing a check to the IRS if you don't figure your withholding amount correctly.

2. Save your refund toward an important goal.

Whether you need to beef up your emergency fund or save for a new home, kids' college or retirement, putting the refund money to work over a long period can be empowering. For example, saving and investing $3,000 per year over 20 years (assuming a constant 6% return) would give you an extra $110,357 for retirement. If you receive a refund and you're not contributing the maximum to your employer-provided retirement plan, such as a 401(k), 403(b) or Thrift Savings Plan (TSP), you could increase the contribution from your paycheck and use the refund for living expenses. An IRA is another great way to save for retirement, and your refund could be a good way to get started or boost your existing savings.

Pro: It's kind of like a double "out of sight, out of mind." You weren't counting on the refund anyway, and now you have it tucked away, working toward your long-term goals.

Con: If you're already done or on track with all your goals, you may not need to save the refund.

3. Pay down high-interest debt.

Many people choose to use their tax refund to pay down debt, and it can be a really smart move. Debt comes in many forms, from student loans to car loans, but credit cards often have the highest interest rates. The higher the interest rate, the more money you end up paying over time and the longer it takes to pay off the debt. If you have debt with higher interest, it can be a great idea to use your refund to reduce or eliminate your debt.

Pro: Reducing debt can provide immediate gratification. If you need help with the process, there's plenty of debt and spending advice available.

Con: If your debt keeps increasing even after using your return to pay it down, you haven't improved your bottom line and may need to look for additional solutions.

4. Spend your refund.

We all need to live a little, and we may have home improvements or things to fix or replace. Many people find that they're happier when they spend money on experiences, rather than just buying things. This is often true even though we spend more time using things than we do experiencing things. Maybe go ahead and earmark your return for that family trip you'll talk about for years to come.

Pro: Life is short and you need to enjoy it while you can.

Con: Life can be long and expensive, and you don't want to run out of money.

Bottom line: Consider your refund options wisely.

You have several options when it comes to your tax return. Whether you decide to adjust your withholdings to limit your refund, use it to build up your savings or pay down a high-interest debt, or spend it on something fun, make the most of your tax refund each year.