More than two-thirds of Americans will receive a personal income tax refund averaging about $3,039, according to the IRS' Statistics. This means a lot of us are overpaying our share of taxes by about $250 per month. It may seem crazy to consistently pay too much for something we don't have to. But when refund time nears, we discuss how much we're getting back as if it were a gift.
Here are four basic options for your refund.
1. Don't receive a refund.
I know this is akin to canceling presents on your birthday, but as mentioned, why lend the government your hard-earned money if you don't have to? There are plenty of psychological reasons why we withhold too much — the "out of sight, out of mind" sort of thing. 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, receiving smaller increases in your paycheck throughout the year 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, 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. Or you could jump-start an IRA that allows contributions up to $7,000 for 2024 (or $8,000 if you're age 50 or older). Also, it's important to understand your IRA options to find the best fit for your retirement goals. To find the best fit for your retirement goals, it's important to understand your options with an IRA.
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. Nice!
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.
Using the refund to pay down debt ranks high on many taxpayers' lists. According to the Federal Reserve Bank, since the Great Recession in 2008, household debt has grown and changed. Student and auto loans have increased significantly, while housing debt is about the same. Although credit card debt has remained constant over the past 15 years or so, it still generally carries the highest interest rates of all unsecured debt. So using your refund to reduce or eliminate debt, especially debt with higher interest, can be a great option.
Pro: Reducing debt can provide immediate gratification. There's plenty of debt and spending advice available to help you with the process.
Con: If debt keeps coming back, 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. According to research from the University of Texas at Austin, we tend to be happier when we spend our money on experiential purchases versus material ones Opens in a New Window. See note 1 This is the case even though we typically 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 before you run out of life.
Bottom line: Consider your refund options wisely.
- Adjust your withholding to limit your refund.
- Save your refund toward an important goal.
- Pay down high-interest debt.
- Spend your refund on something that provides lasting satisfaction.
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