I’m probably not alone in wondering how to spend my tax refund this year. And if you’re like me, you probably also wonder how most people spend their tax refunds? It turns out that strategies vary widely.
Last year, only 8% of respondents to an Edward Jones survey said they would spend their refund on “something fun, like clothes, entertainment, or a meal out.” Another 52% said they’d do the responsible thing and put it toward household expenses or credit card debt.
Yet, I doubt that the survey tells the whole story. There are others among us who get worked up about giving a “free loan to the government.” With the average refund amounting to roughly $3,000, however, investing that money for a year (or less) really won’t return all that much.
Even if you managed to get an 8% annual return on your money and generously assumed the full $3,000 was invested that full period, that amounts to just $240. That’s not that much even in the most optimistic of scenarios.
In fact, judging from how people typically spend their tax refunds, investing isn’t what you had planned for this money anyway, was it?
I’ve written this post assuming that you’re getting close to last year’s average refund (about $3,000) from your 2014 taxes. If your refund is substantially smaller or if you owe taxes, then keep the following in mind next year when you might have a bigger refund check coming your way.
Since there’s no one-size-fits-all strategy or best way to spend your tax refund, here are some options I recommend.
The “I Hate My Student Loan Debt” Strategy
What it involves: Putting 100% of your refund toward paying off student loan debt.
Maybe you’re a student-loan-debt-paying machine and every extra dollar that you get goes toward paying it down. If so, then this is your strategy.
It’s simple: take your full refund and apply it directly toward your student loan with the largest interest rate (or perhaps toward private student loans). Just make sure that the payment is applied toward your principal balance, not toward a prepayment of monthly payments.
This strategy can work with any kind of debt, really. If you have debt higher interest rates, such those with credit card debt, it might not be a bad idea to put your refund toward paying that off, too.
The “Reasonable Compromise” Strategy
What it involves: Spending half of your tax refund on something that you really want and saving half (or using it to pay off debt).
If you’re like me, then your first thought is probably “Wow! $3,000 in free money coming my way!” At least that’s how it seems when you’ve carried on living your life without factoring your tax refund into your finances.
That’s when your voice of reason adds, “Well, I probably shouldn’t go out and spend all of this cash. Especially since I have student loan debt/no emergency fund/a stupidly high amount of credit card debt.”
Yet, I don’t want to be a total buzzkill, either. So I’ll compromise. I put half of the refund toward debt and savings and the other half toward everything else.
If you can put $1,500 toward your student loan principal, then you’ll be that much closer to fully paying off your debt.
And $1,500 to spend as you please? There’s still plenty you can do with that. I’d make some suggestions, but I’m guessing your mind is already running wild with ideas.
The “Straight to the Mall” Strategy
What it involves: Spending your entire tax refund on fun stuff (e.g., gadgets, vacations, eating out).
This strategy is the only option on the list that I absolutely don’t recommend. Why? Because it means that you’re living in denial about your tax refund.
Your tax refund is not free money. It’s your hard-earned money that you paid to the government in advance though you didn’t actually owe it.
Let’s say you get a paycheck this Friday. Once you cash it or deposit it in your bank account, you announce, “I’m going to the mall!” You then proceed to spend every dollar of your paycheck on whatever you want.
While that might sound fun, does it sound like a good idea? I didn’t think so.
The “Pretending It’s Another Paycheck” Strategy
What it involves: Dividing your money as you normally would any paycheck.
This strategy is more or less the most reasonable choice of all. That’s because your tax refund is actually money that you should have received with your normal paycheck but was sent to the government instead.
Even if your refund is larger or smaller than your normal paycheck, just divide the amount the same way.
In this case, divide your money as you normally would. Do you usually spend 15% of your paycheck on paying off student loans? Do the same with your tax refund. Do you usually invest another 10%? Take that same 10% from your tax refund. Does 10% of your paycheck go toward entertainment? Don’t deprive yourself of that money here, either.
The “Actually, I Was Going to Invest That…” Strategy
What it involves: Taking your refund to start or add to an investment account.
Okay, so maybe you’re upset that I suggested that you wouldn’t actually invest your tax refund. Maybe you wish that you could have enjoyed your investment returns on the 12 months that your refund was withheld.
Or maybe you’re just looking to start investing and think that receiving your tax refund presents a good opportunity. You may be right. A $3,000 refund can get you off to a good start and even fund more than half of your Roth IRA for this or the next tax year.
For some guidance, check out our post on starting to invest even if you have student loan debt. Or hop over to our student loan debt repayment versus investment calculator.
The “I’ve Been Screwed by an Emergency Before” Strategy
What it involves: Using your tax refund as a minimum viable emergency fund for crises.
Emergency funds are probably the least fun way of all to use your tax refund. Popular advice says that you should just put it in your account and spend it only if you run out of cash. Other than that, it goes completely untouched.
When you absolutely need money, having an emergency fund can be a huge help. Plus, it’s much better than relying on credit cards—trust me. Credit cards often only get you in trouble when you’re out of cash and lead to more interest charges and more money wasted.
Instead, consider taking part or all of your tax refund and putting $1k (the oft-recommended minimum) toward starting a mini-emergency fund.
For all options:
No matter what you do, make sure to 1) wait until you get your refund to spend any of it and 2) track where you spent (or saved) it once you do.
Doing both will prevent you from spending any money you don’t actually have or double-spending money that you didn’t properly account for.
So, what do you plan to do with your refund this year? Let us know in the comments or on Twitter @StudentLoanHero!