How to spend a tax refund

tax refund

Hey, average American, what are you planning to do with the tax refund you are about to receive? So let's start with useful ideas for spending your tax refund for those in the first stage of personal finance and work our way up to those who are less pinched. Depending on which stage of personal finance describes your current financial situation, your tax refund can help you along if you plan carefully.

Before we go there, though, why are you getting a refund in the first place?

The Arguments Against a Big Refund

First, let's examine the reasons a person shouldn't get a big tax refund. (You've probably heard these statements before!)

  1. “You're giving an interest-free loan to the government!” The implication is that this is a stupid idea, but it isn't quite as helpful as the following arguments.
  2. “You're cheating yourself of cash flow!” If you receive a refund, extra money has been withheld from each paycheck. For some, this money can make a real difference in day-to-day living. In fact, it may be the difference between having to use credit or not. So there is merit to this argument, but it doesn't apply to my situation. I'm not that pinched.
  3. “That money could be invested at a high rate of return!” Now, this argument I grant to be convincing, and I don't have a rebuttal. Not only does a tax refund give your money to the government interest-free, it also deprives you of the opportunity to earn a return on your money.

If there are clear reasons not to get a tax refund, then why do it?

The Argument for a Big Tax Refund

I suspect that everyone who chooses to get a big tax refund does so for the same reason — it's a psychological trick. It's like a self-imposed, forced savings plan. It might be the only way your emergency fund gets started.

Okay? Now back to our options.

How to Spend a Tax Refund (Wisely)

1. Don't spend a single penny before the money arrives in your bank account.
Don't charge something on credit cards; don't promise to spend the money; don't put a deposit down with the rest due the day you expect the refund. You never know what unexpected expense might cause you to be staring down a final payment or contract fulfillment without anything left in your bank account but hope.

2. Don't go on a spending spree after the money arrives either!
Seeing that nice chunk of change in your bank account could put you in the mood to splurge. Instead, deposit your refund directly into your high-yield savings account until you can make a list of all the things you have been wanting or needing over the last year. Then prioritize these items and start making a plan for these funds with the next suggestion.

Related >> Which Online High-Yield Savings Account & Money Market Account is Best?

3. Make a budget or spending plan before you do anything else.
It's amazing how quickly a refund can disappear without a plan. So once you know how much your refund will be, create a spending plan by listing all your income, fixed expenses (bills you have to pay every month), and your debts. Think ahead, too, about any large expenditures that might be on the horizon. With everything listed in one place, you get a better picture of how to make the best use of your refund.

4. Apply the refund to one of your debts.
Do you have credit card debt? You may want to negotiate your credit card balance first. Then, use the refund to pay off the card or make a dent in a card balance. Of course, you can apply the refund to a car loan or student loan debt as well. Pick the debt that bothers you most, or, if they all irritate you equally, pick the one with the smallest balance or the highest interest rate — whatever will motivate you the most to continue your cause to get out of debt.

5. Build your savings.
A refund is the perfect seed money for the emergency fund you have been hoping to start. College savings for your child? Maybe you need to start saving for a replacement vehicle? Are you planning to get married or have a baby? A healthy savings account balance can help you achieve your goals and work toward financial independence, so build your savings with all or part of your refund.

6. Buy things that will save you money.
If your expenses and savings are well covered, you might consider buying things that can help you save money in the future. Think about upgrading windows or adding new insulation (to save on energy costs), get a couple of bus passes or another bulk purchase of something you use very frequently. Maybe a bike could turn your commute into a workout or eliminate the need for a second car, thereby reducing your insurance bill. Maybe you can buy half of a cow from a local farmer, saving you tons all year on quality meat — or maybe a chest freezer to make that possible. Have a baby? Buying a stash of cloth diapers can save you money over time — and save the environment as well.

7. Buy things that will make you money.
Before I talk about traditional investments, I want to encourage you to think about a different way to develop a good return: Invest in yourself. Can you use your refund to help you learn different skills, take an interesting course or go to a conference that can help you increase your income?

8. Invest it.
Use your refund to start funding your traditional or Roth IRA.

Maybe you want to get your own index fund. If all your other goals are met and you are on solid financial ground, you could even use a little bit to buy a few individual stocks just for fun.

If you truly are trying to save with the money, the U.S. government has an option for you: buying U.S Savings Bonds. Instead of getting a cash refund, you can designate up to $5,000 of your refund to be delivered in actual paper bonds issued in your name.

I Bonds are savings bonds that are indexed for inflation. The earnings rate on an I Bond has two components:

  • The first is a fixed rate that remains the same for the life of the bond.
  • The second is the variable “semi-annual inflation” rate. Twice each year (on May 1st and November 1st), this rate adjusts based on the current inflation rate.

The fixed rate and the variable rate are combined to get a composite rate, which is currently 1.48 percent. I know this is a lot of gibberish. All you really need to know is that I Bonds are a safe place to put your money so you don't have to worry about it losing value to inflation.

Because of this, I Bonds are an attractive alternative to a savings account, especially now. They offer higher rates of return, and I Bonds are state- and local-income-tax exempt. (Federal income tax on I Bonds can be deferred until the bonds are cashed in or stop earning interest after 30 years.)

One drawback? I Bonds are not as liquid as high-yield savings accounts. You can cash them out whenever you want; but if you do so before five years, the bond is subject to a three-month earnings penalty. It is sort of like breaking a certificate of deposit early (which is another investment option some might consider.)

Related >> Best CD Rates | Certificate of Deposit Rates

9. Make your life easier.

One of my retired friends has been saving for years and has always tried to be responsible with her money. While she was still working, whenever she got a raise, she increased her contribution to her retirement accounts.

Recently, I met her for lunch shortly after she lost both of her parents. “Once we sell their house, we'll have a small inheritance. I've always tried to save, but this time,” she said in a firm voice, “I decided I don't really need to save any more money. No, this time, I want to use the money in a way that makes my life easier.”

She has a point. We have hardwood floors in most of our house and, while I would eventually like to have a long wool runner in our entry area, I have been making do with a hodgepodge of rugs that are mismatched and cheap-looking. Since they aren't substantial, the little feet that walk on them all day long shift those rugs all over. It drives me crazy. Using part of our refund to buy the rug would definitely make my life easier.

10. Spend 5 percent or so on something nice.
Go out to eat with your family (once). Buy yourself comfortable shoes or some cool, new gadget. (You probably have a favorite splurge.) If you have been wanting to support a local artisan and, again, all your other goals have been taken care of, you may want to use your refund for that too. Work to build strong ties in your community by purchasing groceries for an elderly neighbor, giving a gift to a dear friend, or helping a college student purchase books.

As you can see, there are a multitude of ways to spend your refund. Use it wisely and it could motivate you to even greater financial success!

If you are expecting a tax refund this year, how do you plan to spend it? Was it a fluke, or is getting a refund part of your strategy?

[Editor's note: An earlier version of this article appeared on February 2, 2012. The original comments were retained in case they provide value to the reader today.]
More about...Taxes, Budgeting, Planning

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MoneyforCollegePro
MoneyforCollegePro
8 years ago

My No. 1 DO NOT DO with a tax refund is to get a Refund Anticipation Loan (RAL) and pay interest to receive your refund early. Don’t spend money without cause!

Cybrgeezer
Cybrgeezer
8 years ago

I’m a little surprised that, at 10:41 a.m. EST, I’m the first person to give this important suggestion a “thumbs up.”

Florida Bill
Florida Bill
8 years ago
Reply to  Cybrgeezer

Just a thought, but it might be because this board is made up of readers who already know this is a bad idea and see no need to comment or ‘Like’ a very good, and very basic, suggestion.

Beth
Beth
8 years ago
Reply to  Florida Bill

Or the fact the “like” button doesn’t always work. (At least it doesn’t for me!)

SB @ One Cent At A Time
SB @ One Cent At A Time
8 years ago

The No#2 for DO NOT DO with tax refund, is plan any spending around it. I let it go quietly in to my retirement account. My take home pay is enough to cover for spending needs. This is extra money, I should spend when I am not earning any more.

Joanna
Joanna
8 years ago

Then why not just reduce the amount you pay in tax each paycheck to better reflect what you owe, then increase your retirement contribution throughout the year? You’re throwing away retirement interest/growth for nothing. At least some people claim they’re doing it because they want to have a “forced savings”.

Money Infant
Money Infant
8 years ago
Reply to  Joanna

That is pretty much what I’ve done. As a self employed individual I’ve found that it was necessary to file quarterly taxes. In the beginning it was a bit of a pain in the a**, but I have come to really appreciate the increased control I now have over my taxes. Once a year isn’t enough to get a true picture of how to reduce your tax burden, but with quarterly payments I get to make tweaks 4 times a year. And I am never more than $100 off one way or another when I file in April. #3 DO… Read more »

SB @ One Cent At A Time
SB @ One Cent At A Time
8 years ago
Reply to  Joanna

Thanks for the alternate view Joanna. To me, there is no single way of doing thing. You are right I do it to keep my spending in control. It may work better for you to reduce withholding to pay lesser taxes from payroll. For me its another way to save extra money.

Elizabeth @ Broke Professionals
Elizabeth @ Broke Professionals
8 years ago
Reply to  Joanna

I agree with your sentiments, Joanna. My dad’s a tax professional, and for years he’s urged me and my husband to change our withholdings so we get more money in each paycheck. I’d always loved getting a big refund check and was reluctant to make the switch… last year was the first year we finally did so, and it made a huge difference! There’s no going back now.

Joe
Joe
8 years ago

In Canada, we get a larger tax refund when we put money into RRSPs (Registered Retirement Savings Plan) – it’s similar, in my understanding, to a 401k. I’ve been putting my tax refunds (larger because of the RRSP deduction) directly into my TFSA (Tax-Free Savings Account). The TFSA is filled with after-tax dollars (and then it remains tax-free forever, if used properly), so it seems perfect to fill it with a large tax refund ๐Ÿ™‚

Elizabeth
Elizabeth
8 years ago
Reply to  Joe

Me too! This year I’m thinking TFSA instead of RRSP for a good portion of my refund even though it will still be earmarked for retirement. I’m trying ti diversify a little more.

Marianne
Marianne
8 years ago
Reply to  Joe

I’ve had more than one person this year tell me that I should be putting my money into TFSA’s rather than RRSPs with no knowledge of my financial situation. I am not sure where this info is coming from. I am fully aware that there are some times when a person would be better off to use a TFSA to an RRSP however, in my case with no pension etc., I could put $100 into a TFSA and pay no tax on the interest earnings. Or I could put $100 in my RRSP get back $40 from the government and… Read more »

Beth
Beth
8 years ago
Reply to  Marianne

Funny, I keep seeing the opposite! People keep telling me to put money in an RRSP so I can take advantage of the home buyers plan. (Not sure I will, though.) My advisor recommended I put my home down payment in the TFSA to shelter as much of it as possible from taxes.

Once I buy my home, I’ll deal with whether the TFSA should be for part of my retirement plan and for my emergency fund. Right now it already has a job.

So You Think You Can Save
So You Think You Can Save
8 years ago

We earmark most of ours for various savings goals we have, including saving for when we need to replace the car, car and home repair work, major expenses for the kids. We do put aside around 10% for travel and vacation so that’s pretty much the fun aspect of it.

Elizabeth
Elizabeth
8 years ago

All good tips! My tax return is no where near that high, but this is the first year majority of it won’t be going towards student debt. I noticed charity was left off this list. I know many people tithe or give a portion of their income to good causes — and isn’t a tax return technically income? Even if people (wrongfully) view it a mini windfall, many people still donate part of a windfall. I am by no means saying anyone has to give away any of their income or tax return. I was just surprised to see it… Read more »

Jennifer+B
Jennifer+B
8 years ago
Reply to  Elizabeth

No, a tax return isn’t technically income – it’s SAVINGS. You gave it to the government to pay your taxes and you gave them more than they need, so now they are giving it back to you. While I understand that the post is about what to do with this kind of windfall, I wish that it had touched just a bit on making adjustments to your withholding for next year to get more of that money into your pockets each payday instead of giving it to Uncle Sam for many months instead. Think of the interest you wouldn’t have… Read more »

Florida Bill
Florida Bill
8 years ago
Reply to  Jennifer+B

Actually, a tax RETURN is neither savings or income nor, for that matter, investment or funding for a splurge. Those are possibilities for your REFUND. The return is the form you file; everyone files a return, some get refunds.

I’m not a grammar Nazi, but the misuse of some words/terms we all should know bothers me.

BTW, the article, both in the headline and content, uses the term ‘refund’ correctly without calling it a ‘return.’

Elizabeth
Elizabeth
8 years ago
Reply to  Florida Bill

D’oh! You’re right of course. Serves me right for reading GRS before breakfast. (I am sooo not a morning person.)

REFUND REFUND REFUND. There. Now it should stick.

mike
mike
8 years ago
Reply to  Florida Bill

Bill aren’t we splitting hairs here. Isn’t the word refund a synonym of return? When I read the word return used above, I’m reallying reading refund. So while everyone files a “Return” you can only spend or whatever a return(refund). Inherently the article is discussing a refund and the comments are discussing what they do with their return(refund) not about filling out a return form.

Elizabeth
Elizabeth
8 years ago
Reply to  Florida Bill

@Mike I appreciate the back up ๐Ÿ™‚ It was a silly error on my part and I’m willing to learn from my mistakes. I’m giving Bill the benefit of the doubt and assuming he didn’t mean the last part of his comment to sound snarky.

Vanessa
Vanessa
8 years ago
Reply to  Florida Bill

Some people call it a return, because it is taxes that are returned to them.

I always call it a refund but I have no problem with either term.

Shane
Shane
8 years ago
Reply to  Jennifer+B

I could not agree more. Every year after I complete my tax return I fill out a new W-4 to adjust my withholding for the next tax year. If you are getting a large refund consistently, you need to adjust your withholding as well. It is very easy to adjust your W-4. In fact, the IRS has a w-4 calculator on their website that will help you do just that. Since I itemize my taxes each year, I usually estimate my withholding counting all of my expected deductions other than charitable donations. That way I know I should never under-withhold,… Read more »

Elizabeth
Elizabeth
8 years ago
Reply to  Jennifer+B

Good point! Or the interest you could have earned had you had saved/invested the money within a TFSA rather than giving it to the government. (Or IRA? I’m still not sure how things work in the U.S., sorry!)

PawPrint
PawPrint
8 years ago
Reply to  Jennifer+B

But if you get a refund, don’t you have to include it on your tax forms the next year so that the refund is included in your gross income?

bdoubleu
bdoubleu
5 years ago
Reply to  PawPrint

Ahh!! No, this is so incorrect. A tax refund from 2014 would NOT be counted as income in 2015. It was money you earned in 2014, over-payed in taxes, and is now refunded to you. You’ve already payed taxes on it.

Julie
Julie
5 years ago
Reply to  PawPrint

This would be true for state taxes, unless you are paying AMT and your state taxes are no longer deductible. State taxes are deductible for Federal Taxes, thus if you get a state tax refund, it becomes income on the Federal Tax refund in the year received.

Courtney
Courtney
8 years ago
Reply to  Elizabeth

We used to tithe – and we tithed on our pre-tax income, so the refund was never considered part of our income because it didn’t matter how much or how little was taken out of our paychecks in terms of how much we gave to the church (it also made our pledges a lot easier, because we knew exactly what our salaries were versus variable paychecks). I suppose if you tithed on post-tax income then for the purposes of a tithe the refund would be considered “income” – but if you owed money instead, you can’t ask your church to… Read more »

Elizabeth
Elizabeth
8 years ago
Reply to  Courtney

See, that’s where I get confused — I know people who do tithe based on gross income and people who tithe based on net. No judgment either way — I was just wondering how the tax refund figured into the income.

PB
PB
8 years ago
Reply to  Elizabeth

Ideally, one should tithe on gross income, not after tax, because that is what your income truly is. However, it is very hard to do at times, and so our church encourages us to work towards it. Frankly, if our members just tithed their net income, we would have a lot more for missions!

Jacque
Jacque
5 years ago
Reply to  Courtney

We tithe on a pre-tax basis as well. It is a hot-button issue, no? I think “Give to God what is God’s and give to Caesar what is Caesar’s” sums it up nicely and people just over-complicate the issue. If we give our daughter $1 for allowance and wanted to teach her about personal finance, we’d have her give $0.10 for tithe and $0.15 (or whatever ridiculous rate it becomes) for tax. It doesn’t matter what order they are distributed, the portions remain unchanged. To tie it back to the refund issue, it wouldn’t matter if we decided that “oh,… Read more »

Sarah Gilbert
8 years ago
Reply to  Elizabeth

Elizabeth, you’re right — as I went through the process of writing this post I just didn’t think of charity. Ironically, this morning, as I glanced at the comments in my inbox I also renewed my membership to a bicycle association and considered whether it was a good time to give the money I like to give annually to my undergraduate institution. I’m unchurched right now (a crisis of faith in churches, not a crisis of faith so much), so there’s no opportunity to tithe. I will, however, send a little money to my sister in Panama, where she and… Read more »

Amy
Amy
8 years ago
Reply to  Sarah Gilbert

Don’t want to thread jack or start an argument, but….am I wrong to think that a tithe can still be tithe (pre or post tax doesn’t matter to me as it does some people) regardless of whether it goes to a church or not? I’m unchurched at the moment for both reasons you offered but I still give. Not a tithe, but I still give a portion of my income. I know others who tithe – as in give 10%, but not to a church per say. Anyway – I think that charitable donations are a good way to spend… Read more »

Elizabeth
Elizabeth
8 years ago
Reply to  Amy

@Amy and Sarah — There are so many levels to the debate on tithing ๐Ÿ™‚ I’m looking to join a church, and it’s going to be a challenge trying to marry it’s expectations with what I currently do. I mainly brought up the idea because when I didn’t have a lot of money (like in my grad student days) reserving a portion of any “found money” for charity was a way I could give back. Some people would fault me for even doing that much as I was accruing student debt, and some would say it wasn’t enough. You can’t… Read more »

Jacque
Jacque
5 years ago
Reply to  Sarah Gilbert

Whenever my husband and I have been between churches do to moving, etc. we have always continued to give. We just increased our contributions to missionaries and charities that we also support so that our giving level remains consistent!

KSK
KSK
8 years ago

I am self-employed and have been for 15 years. If I pay too much in taxes for the year, I just have the overpayment (tax refund) applied to the next year’s quarterly tax payment.

I haven’t seen a tax refund in a very long time.

Dogs or Dollars
Dogs or Dollars
8 years ago

I am very curious as to these wool comforters. Hmmmm… My list is already started. I do this will pretty much all “known windfalls” a few weeks before they are destined to show up. Take guesstimated amount and allot it to certain categories/expenditures. We can discuss and tweak this before the money even hits the banks account. When it shows up, I know where it’s all going. The money is usually gone after a few quick transfers and ‘check out’ clicks, removing any temptation to deviate from the plan. Course, a chunk of ours will be going to a new… Read more »

Sarah Gilbert
8 years ago

Dogs or Dollars, you’re a spender after my own heart ๐Ÿ™‚ I bought a wool comforter, through a buying club, from a local company — Wisdom of Wool — and the locally made latex mattress is on my long-term list. If I sell my book… or maybe my second book… I’m getting a lovely new mattress! so far in my adult life I’ve only owned hand-me-down mattresses. a pity.

Eileen
Eileen
8 years ago

I’m confused about #2. I understand the idea of killing off a debt, but confused about negotiating down what’s owed with a credit card company. Don’t you owe that amount? Didn’t you accumulate the debt and interest?

This article isn’t about keeping a roof over your head, it’s about what to do with a tax refund. Why would a credit card company forgive some of your debt in this scenario?

Maybe I’m missing something, if so my apologies.

Brenton
Brenton
8 years ago
Reply to  Eileen

In the scenario Ms Gilbert wrote about, the card account had been closed and was no longer active. Even being closed, she still owed the remainder of the balance on the account when she closed it, which had been there for a long time. In these situations, the credit card company might accept a lower amount in a one time payment because such long-closed accounts are prime for defaults. So they take a loss of potential profit in order to assure themselves of making some money. Some companies might say no, but generally speaking, the longer its been closed the… Read more »

Eileen
Eileen
8 years ago
Reply to  Brenton

Thanks for the explanation. I’m still puzzled at using that approach because, well…you can. If someone is getting “a tad bit less” than $7500, it stand to reason they can (and should) continue to re-pay their debt.

I realize this is judgmental and may not be kind, and perhaps I’m just naive.

I’m just struggling with a large tax refund, the discussion of custom made comforters or doing something nice, and then suggesting you negotiate on a debt that you owe.

I still must be missing something.

Ash
Ash
8 years ago
Reply to  Eileen

The answer is, because you can ๐Ÿ™‚

It’s just a common practice of creditors to accept lower payments in exchange for finally being able to take an account off their books.

Negotiating is just another way to save money, there’s nothing morally wrong with this. Would you not negotiate the best terms for a loan, even if you could afford to pay more?

Brenton
Brenton
8 years ago
Reply to  Eileen

Well, not paying it would be ethically questionable, but offering the person/company you owe the money to a different payment option(ie: Ill give you $500 NOW rather than $50 a month for a year), and giving them the option of not taking it doesnt seem unethical at all. You are still paying the money back. The other person/company is still satisfied with the result, so I dont see why it would be morally or ethically wrong at all. After all, the collection agency could just say no, take you to court and snag every last dollar of that refund until… Read more »

Heather
Heather
8 years ago
Reply to  Eileen

It’s the same ethical effect of negotiating a lower interest rate, or a higher salary. As in, totally accepted and expected, not anything wrong or hurtful at all. Keep in mind, for every month of payments that need to be made on a debt, the company holding the debt has to employ someone to track the expected payment, receive the payment, check it off, allot the income, etc. etc. For a multi-thousand dollar debt that could be years to pay off at the current payment plan, getting (as in this case) $1000 knocked off the debt to have it settled… Read more »

Julie
Julie
5 years ago
Reply to  Brenton

I don’t believe that negotiating down a debt after a contract is signed even though you have the money to pay is the ethical equivalent of negotiating a lower interest rate or better terms prior to entering a contract.

Sarah Gilbert
8 years ago
Reply to  Eileen

Eileen, this may be a case of one’s ethics as they collide with the realities of financial institutions. I did indeed spend the money (more than a decade ago. I was young and stupid!). but at this point the credit card company has long since sold the debt at a huge discount to a collections company, to whom I am paying. they’ve already made back all they paid for my debt and more. I could pay every penny, indeed; but that money would only go to buy a slightly nicer car for the principals of the collection company. as it… Read more »

Nicole
Nicole
8 years ago

Why not just stick it in an IRA?

Of course, ours (when we have a refund) always goes right back out towards estimated taxes for the next year.

Todd
Todd
8 years ago

As a side note, why are you getting a refund at all? If you did better tax planning, you wouldn’t get any tax refund. The refund means that you paid too much to the government over the course of the year, and earned no interest on that money between when you paid it and when you received it back from the government. If you want, you can give me $7500 today, and I will give it back to you a year from now. Feel free to spend 5% of the money I return to you on a splurge.

Brian
Brian
8 years ago
Reply to  Todd

You made the same point I was going to make, but after further consideration I realized that some people can pay nothing in all year and still get a refund with all the credits and deductions that are available these days.

Courtney
Courtney
8 years ago
Reply to  Brian

Sarah specifically mentions the EITC, child tax credits, and the combat pay exemption. I doubt there was anything they could have done to their withholdings to account for all of that.

Marsha
Marsha
8 years ago
Reply to  Courtney

I don’t know about Sarah’s specific situation, but I compute what our tax liability for a year will be after all deductions and credits, and then adjust the number of exemptions based on that. We’ve claimed as many as 18 exemptions (family of 4) to make our withheld amount nearly equal to our tax liability for the year. That way, we keep more money in our paychecks. I usually have to write a small check to the IRS in April.

Courtney
Courtney
8 years ago
Reply to  Courtney

Right, but the EITC and child tax credits are fully refundable (meaning you can get more back than your tax liability). But taking an infinite number of exemptions isn’t going to get you to the point where the IRS will add that money to your paycheck in lieu of sending it to you when you file your tax return ๐Ÿ™‚

Courtney
Courtney
8 years ago
Reply to  Todd

We do the best we can – one year we owed $12. But things don’t always work out quite that well and I know we are going to be getting a large refund this year for two reasons: 1) We put our condo on the market last March and figured our tax bill under the assumption that we wouldn’t have enough deductions to itemize. Well, the condo didn’t sell until September and the additional mortgage interest pushed us above the itemization threshold. 2) Hubs received an unexpected bonus in December, and his company does weird accounting on bonuses such that… Read more »

Sarah Gilbert
8 years ago
Reply to  Courtney

Courtney, that’s not weird accounting but the way nearly all bonus income works. It’s taxed as though it was the annual equivalent of whatever pay period basis your husband’s company operates on — so, if you get $10,000 bonus on a twice-monthly pay-period paycheck, you’ll be taxed at the rate for $240,000. some employers let you change your withholding just for that pay period, but it’s a pain, so most don’t.

Shane
Shane
8 years ago
Reply to  Sarah Gilbert

Sarah, that is not completely correct. Bonuses are considered “supplemental wages” by the IRS and employers are permitted to withhold federal taxes at either the same rate as they would for regular wages, or they can withhold at a flat rate (meaning they withhold at the same rate for all employees, regardless of their W-4 elections). Many employers choose the “flat rate” option, which is typically a much higher withholding rate (as a percentage of income) than the rate for regular wages. A typical flat rate many companies use is 25%. This only applies to the federal income tax withholding… Read more »

Sarah Gilbert
8 years ago
Reply to  Sarah Gilbert

thanks for the clarification, Shane. it’s been a long time since I worked as the One Who Decides Payroll Things at a small company and I’d forgotten about this (or skipped over it because our bonuses were usually paid monthly). in any case, thank you!

ali
ali
8 years ago
Reply to  Todd

I know this is going to sound ignorant -but how do you do this?

Guy
Guy
8 years ago
Reply to  ali

Generally speaking, the easiest way is to get more up front is to increase the number of personal withholding exemptions you selected on your Form W-4 (likely when you started your job). If you contact your HR department, they should let you update that number appropriately. However, note that if you take too many, you may wind up swinging the pendulum too far and owing taxes when you submit your return.

Sarah Gilbert
8 years ago
Reply to  Todd

Brian and Courtney are right. we paid $0 in tax withholding this year — I’m a freelancer (who makes a lot less when my husband is overseas thanks to the work of juggling the house and children on my own) and my husband is currently in a combat zone, where taxes aren’t withheld or owed. someone else correctly noted that, technically, it’s not a “refund,” but an “entitlement.” (oh how I hate that word! a post for another day.) many of you probably think it’s unfair that your tax dollars are going to those of us who don’t make much… Read more »

Courtney
Courtney
8 years ago
Reply to  Sarah Gilbert

Sarah, I DON’T think it’s unfair and as a taxpayer who has never had to make the sacrifices either you or your husband has, I’m more than happy to help cover your share.

Incidentally I think it’s worth pointing out that those who would froth at the mouth about the 47% who “don’t pay taxes” probably never even think of people like you and your husband.

Shane
Shane
8 years ago
Reply to  Courtney

Agreed. I wish there was a way you could direct how your tax money is spent, or at least give a preference. I believe our armed forces are underpaid and under-appreciated.

Sam
Sam
8 years ago
Reply to  Todd

I’m glad someone finally made this point, a tax refund, in most cases, means you gave the government an interest free loan. Better to adjust and make sure you get a very small refund or even if you have to pay a little.

Heather
Heather
8 years ago
Reply to  Todd

I personally haven’t had a steady income since I started working. Being on the verge of (and dipping into periods of) disability means that while my taxes may be set perfectly for a minimal owed/refund when I AM working, the subsequent unemployment for part of the year may mean I get a huge refund, like I did this year. Heck, I got back more than I paid. I point this out to you because it’s important for people to know that it’s not always an issue of “bad judgment” or lazy accounting. Sometimes getting a refund every year is simply… Read more »

Jake
Jake
8 years ago

Your tax refund should never be that high. Adjust your W-4 by increasing your exemptions.

Sara
Sara
8 years ago
Reply to  Jake

Jake, you’re exactly right, but it’s sort of confusing to figure out how to do that, especially when you’re not sure what the next year holds. For example, am I buying or selling a home? Will I get a big raise? Will I leave my job for another one with substantially different pay? I would be interested in hearing more about how people decide the exemptions/withholding.

Emily
Emily
8 years ago
Reply to  Sara

Use the IRS withholding calculator. http://www.irs.gov/individuals/article/0,,id=96196,00.html

The calculator lets you put in how much income and tax you have already paid for the year and estimate deductions. I put a reminder on my calendar every quarter to reevaluate and make any changes required.

csdx
csdx
8 years ago
Reply to  Sara

The easiest way is take your finances from last year and maybe take a few educated guesses like factoring out any one time things, fill out the estimator tool. Then if during the course of the year something drastic happens to change your tax situation, (big bonus, or bought a house, sold some stocks, etc) just fill out the estimate again based on the new info. You’ll get accurate information because it takes into account the income and taxes you’ve already done for the year, and will tell you how to adjust the numbers to end up on track for… Read more »

Sara
Sara
8 years ago
Reply to  Sara

Emily and csdx, thanks so much!

Poor to Rich a Day at a Time
Poor to Rich a Day at a Time
8 years ago

Not everyone overpays to get a refund, it is an income source when a large refund comes because you did not make that much money so you get earned income credit when you are pretty much exempt from taxes and not paying federal taxes on your income. For us, we are dividing our refund up to help boost our monthly income for the whole 12 months of the year. This is a huge relief to me knowing we will finally have a stress free above survival mode life this year after 2 years of barely making it. A monthly boost… Read more »

Shane
Shane
8 years ago

What you are describing is the earned income credit, which isn’t really a refund (since the money was never yours in the first place) but rather is a government entitlement program (similar to welfare) that helps supplement income for low income families with children that are working. I am glad to hear that my tax dollars are going to help people that really need the help. I volunteered for several years at a tax preparation clinic run by the IRS that targeted low income families that would benefit from the earned income credit. I prepared returns for many people whose… Read more »

Heather
Heather
8 years ago
Reply to  Shane

“helps supplement income for low income families with children that are working.”

I don’t have children (single, only me in my tax household) and I get the EIC. So “families” and “with children” would both be inaccurate in that statement. Of course, you have to have earned income to get the earned income credit.

Beth
Beth
8 years ago

Kudos, and best wishes for the year ahead! ๐Ÿ™‚

Caleigh
Caleigh
8 years ago

This is really great timing! I just received my tax return and although it’s nowhere near the amount listed in this post, it’s a little something extra. Unfortunately, I have to spend part of it on a bridesmaid dress I wasn’t counting on paying for until a later date. Oh well, at least I know where the money is going!

Nick
Nick
8 years ago

Yea… like a few other commenters have mentioned, I feel like the last step, after you do all this stuff, should be to re-evaluate your tax withholdings. Remember that a tax refund basically just means you gave the government an interest free loan for the last year. I have some family members that actually use a tax refund as a sort of savings account. The purposefully fill out their taxes so they get these huge refunds… which I never understood. As a general rule, it’s always better to have cash now rather than later so if you’re getting huge refunds… Read more »

Rosa
Rosa
8 years ago
Reply to  Nick

If a large but unpredictable amount of your income is bonus or commission, aiming to not overwithhold can leave you owing a large amount at the end of the year. Some of the years I was on commission, even having a 1 or 0 on my W-4 left me with a refund big enough to go on a nice vacation.

Rosa
Rosa
8 years ago
Reply to  Rosa

(and now that it’s too late to edit, I realize it’s been so long since i made a lot of commission, I forgot how the W-4 figuring works – that should say “even claiming 4 or 5” not 0 or 1.) The recession has made my income a lot more predictable.

Laura
Laura
8 years ago
Reply to  Nick

I am apparently in the minority of being one of those people who is perfectly fine with giving Uncle Sam an interest-free loan for a year. Why? Well, as J.D. and others have said before, personal finance is as much (or more) about your mindset than anything else. To me, knowing that I will absolutely NOT have another unexpected expense landing with a whump on my doorstep by April 15 is reason enough to have more withheld than is necessary. I know when I do our taxes that we will not have to pay any more money; I know we… Read more »

csdx
csdx
8 years ago
Reply to  Laura

Certainly if you need a kind of forced savings vehicle it can help, you can even ask for more to be withheld to make it a savings goal, the government’s certainly not going to complain that you’re giving them more money. Though I find it much better to just split out your paycheck yourself. If you’ve got a direct deposit, often you can direct funds to multiple accounts. So you can put that money aside without ever having a chance to spend it early. Just take that extra money you would’ve put toward excess taxes and instead fund an account… Read more »

Jill @ Dollars-or-Cents
Jill @ Dollars-or-Cents
8 years ago

I think it’s silly that the tax system is so confusing that it’s difficult (for me at least) to anticipate my tax refund, which prevents me from being able to plan my finances with a complete picture. Due to that, I don’t make any plans dependent on my refund, and just stick it into my savings account when I get it. Although I’ve been filing my own returns for a while, I suppose I should put in the time to understand exactly how it all goes down, so that it’s not so “black box” to me. Until then, this advice… Read more »

Bethany
Bethany
8 years ago

Wool underwear?

Sarah Gilbert
8 years ago
Reply to  Bethany

as lingerie is to some women, wool underwear is to me. I started buying them this fall (all on sale so I did *not* pay $28 a pair) — http://us.icebreaker.com/Bikini/IBA377,en,pd.html?dwvar_IBA377_color=F46&start=1&cgid=womens-underwear-panties they’re comfortable, natural fibers (very important for the stuff close to my skin), wicking, and wool has natural antibacterial properties. they last a lot longer than cotton and don’t stretch out like microfiber. sadly, I’m going to have to wait to buy some more until the next big sale or when I sell a literary piece, as I’ve already committed all my money from the taxes to other things. now… Read more »

Bethany
Bethany
8 years ago
Reply to  Sarah Gilbert

I never thought I would want wool that close to my bum but those look pretty comfortable. ๐Ÿ™‚

John | Married (with Debt)
John | Married (with Debt)
8 years ago

While we don’t spend it before we get it, we do earmark it well before we get it.

This year it is going towards a European vacation.

Last year it was our daughter’s tuition.

I recommend people max their exemptions to make their paychecks bigger and their refunds smaller, but some just prefer letting the government hold their money so they won’t spend it.

Florida Bill
Florida Bill
8 years ago

I unsuccessfully used that argument with a friend who is proud that her annual tax refund is a minimum $6,000. When I pointed out (years ago) that it amounted to an interest-free savings account with the government, she was OK with that.

Today, of course, it’s harder to make that argument because interest on savings, money market accounts, even CD’s is near zero.

Beth
Beth
8 years ago
Reply to  Florida Bill

Especially if you have to pay tax on any interest. I just got my T5 slips for my non-TFSA accounts. The interest earned is small enough without the government taking a cut.

Eric
Eric
8 years ago

I treat it like savings. Put most of it in my EF. Being a single parent, my taxes vary from year to year. I adjusted my W4 to break even on the years I don’t have a dependent but I don’t change it for the years I have a dependent. Which means I get back a chunk of change those years. I don’t want to keep messing with my withholdings every year so I am fine with a refund every other year.

Shawn G
Shawn G
8 years ago

We owe again this year, so I will not be getting a refund. My wife’s part time job never takes out enough taxes, so we get hit every year. It’s become par for the course, and the money is already set aside, but one of these years I would like to break even.

Courtney
Courtney
8 years ago
Reply to  Shawn G

My husband and I have roughly equal salaries, so even at 0 federal exemptions we come out about $6K short on withholding. We pay quarterly to make up the excess.

mary w
mary w
8 years ago
Reply to  Courtney

Courtney – You can also have them withhold a certain dollar amount above and beyond the number of exemptions claimed. That’s what I do. For example, married, 0 exemptions, plus $123. You can also claim “single” on your W-4 even if your married and filing jointly.

This is easier to me than having to remember to file quarterly.

Courtney
Courtney
8 years ago
Reply to  mary w

You can – but along the same lines of over-withholding and “why let the government keep your money interest free?” why would we let them take it out of every paycheck when we can stick it in a savings account and earn a little interest on it? Granted last year it was only about $11, but you see the point. I don’t have to remember to file quarterly – I do the form in January and set up four equal automatic payments. It’s much easier to do that online instead of having to submit forms through one or both of… Read more »

Diane
Diane
8 years ago

I second all the comments about adjusting your withholdings. I’m not a CPA and I don’t play one on TV, but I believe the rule is that you must only withhold an amount equal to what you owed the previous year to stay out of the IRS penalty box. I watch this amount carefully and then claim EXEMPT for the rest of the year. Works like a charm. If my income was drastically increased, I’d save some extra in an earmarked account. Unless you are self-employed as KSK #6 is, there is no reason to stockpile your cash in Uncle… Read more »

Vanessa
Vanessa
8 years ago

The best part is that I can count all these expenses against my income on next yearโ€™s taxes!

I would love an article about how education/job search expenses can reduce your taxes.

Ms Life
Ms Life
8 years ago

One thing I usually do when I know I will get a windfall is go window shopping first if I have some big purchases to make. This helps me know exactly what the price is and where I have to get it. It also eliminates the temptation to buy other things while searching for what I need. This method has served me well in the past.

Sarah Gilbert
8 years ago
Reply to  Ms Life

smart, Ms Life. it’s nice to have the thing in front of us to work toward with our savings.

Michele
Michele
8 years ago

I’m concerned about #2. In my experience, this causes a Charge-off to be reported to the credit agencies and will stay on that report for 10 years. It’s extremely difficult to get new credit or lower interest rates with that on the report. And, as a previous commenter mentions, the credit card company may send a 1099 and taxes will need to be paid.

Amy
Amy
8 years ago

What is this tax refund of which you speak?

doug_eike
doug_eike
8 years ago

Frankly, I’ve never understood why people consider a tax refund to be some kind of yearend bonus that they can play with. Saving money is so difficult that, in my view, the refund should go automatically into savings.

In the days when we got interest on our money, it made no sense to have a tax refund–all it meant was poor planning, loaning money to the government and losing the opportunity interest.

Courtney
Courtney
8 years ago
Reply to  doug_eike

See my comment #21 on how, even with the best of planning, things don’t always work out perfectly. I do the estimated tax form every January and pay quarterly to make up the difference between what we have withheld and what we owe, but sometimes things happen late in the year that throw everything off.

Thad P
Thad P
8 years ago

My number one thing would be to look again at my W-4 to see why I had so much money come to me in a refund. Letting the government have an interest free loan isn’t the best way to go.

Cheryl
Cheryl
8 years ago

I’ve seen people question about getting a return or refund at all, suggesting the lack of proper tax planning. I personally claim the maximum deductions, have near zero tax taken out of each pay check and I still receive money back-legally- every year. I get money back and have extra income in my check every payday What would you suggest I do to be “smarter” about my taxes?? In my case it’s because of all the deductions I’m allowed and that my DH income is not taxable.

Carla
Carla
8 years ago

No refund this year; I actually owe money for the first time ever.

Carla
Carla
5 years ago
Reply to  Carla

Same this year.

Eileen C
Eileen C
8 years ago

I’d always known that over-payment of withholding amounted to an interest-free loan to the government, but until this past year I didn’t have the mind-set to change my choices. Reading this blog helped me to do that. I used to use withholding as enforced savings, i.e.,I never would have put that money aside myself if it came in my paycheck. I would use my tax refund to pay bills, pay off a purchase I’d made with the refund in mind, or use it for a vacation. Supported by info from this blog, I made some changes to how I think… Read more »

Kurt
Kurt
8 years ago

9. If you have an employer, submit a new W-4 and have less tax withheld in 2012! If you’re self-employed, re-look at your planned 2012 tax installments. Then revisit 1-8 to consider what to do with the increase in take-home pay you’ve given yourself.

Sara
Sara
8 years ago
Reply to  Kurt

You should also assess your state income taxes and adjust withholding there, if appropriate, as well.

Bella
Bella
8 years ago

Great article Sarah, For every one chiming in about why you would keep such high withholding, poor planning and the like. We give an interest free loan to the government every year, and it’s a big one. You want to know why? Because the year after we got married we tripped over some special clause which meant we could no longer deduct a bunch of stuff we could previously, and we ended up owing almost as much as we usually got in a return, and then I asked the million dollar question – why didn’t we hit this limit the… Read more »

Michelle @ Making Sense of Cents
Michelle @ Making Sense of Cents
8 years ago

I’m hoping to save some and put some towards debt.

Keith
Keith
8 years ago

I would change the school of thought and say don’t get a tax return. Change your deductions so you break even at the end of the year, and budget your monthly income/expenses appropriately.

Shawn
Shawn
8 years ago

To everyone saying that getting a big refund is bad tax planning, etc. You seem to be forgetting one of JD’s most important personal finance rules. Do what work’s for you.

If someone does not have the discipline to save throughout the year, then setting themselves up to get a large refund is not a bad way to “force” yourself to have a savings.

This is the same concept as the snowball method of paying off debt.

It doesn’t make sense by the numbers, but you should never underestimate the power of psychology.

Sarah Gilbert
8 years ago
Reply to  Shawn

Shawn and others, yes. I think I linked to J.D.’s piece on being ok with giving the government an interest-free loan ๐Ÿ™‚ after all, I do like a lot of what the government does! Parks, for instance. Awesome. And I’m so, so happy *I* don’t have to go around collecting a percentage of all my neighbors’ incomes to pay for roads and senators! I’m thrilled the government does that for me. and then there’s the part about “what works for you.” Even if I have an uncharacteristically good month with savings, it seems my husband chooses that month to be… Read more »

Courtney
Courtney
8 years ago
Reply to  Sarah Gilbert

Interestingly it was that article that first brought me to GRS – I was arguing against purposefully getting big refunds and someone posted that link as a rebuttal.

PB
PB
8 years ago
Reply to  Shawn

We have had such odd things happen to us lately, like kids leaving home and returning, parents dying and leaving us things, and so on, that I have purposely had more withheld than we probably need. I would rather get something back than try to find the money later. And interest rates are so low that it’s pretty much a wash anyhow.

This year, if we get anything back, it’s all going against our mortgage, our last major debt. We have $ 15,000 left to pay off and I want to wipe it out this year!

Sara
Sara
8 years ago

I’m curous about only 5% towards splurges. Maybe I’m bad about spending, but we usually take a couple hundred and put it towards wants – this year we’re going to get a dining room set that isn’t on its 4th owner from the 70’s, badly scratched with ugly upholstry and wobbly legs. Sure we can make do with the set we have, so I know this is a want. The rest will go to savings/debt reduction/something responsible. And yes, we usually aim to break even, but the last few years have had a lot of odd tax implications – buying… Read more »

SimpleIslandLiving
SimpleIslandLiving
8 years ago

Usually I put all the money into savings. It goes into the e-fund, savings account – or sometimes we use the money as *play* money for investments. (I call it play money because, well, we’re playing the stock market with it).

Random+Anonymous
Random+Anonymous
8 years ago

The $7500 refund is not surprising from a few key phrases: 1)Our 3 young boys … $1000 per child refundable tax credit $3000.00 2)Earned income tax credit based on her reduced income … refundable tax credit which may approach $5000.00 3)Income from a war zone is tax free. The only change to reduce a refund would be to insure that there is no withholding from the pay earned in a war zone. I don’t know how to get the child tax credit or EIC paid to you before submitting your tax return. Also, I appreciate the sacrifices made by soldiers… Read more »

bkwrm
bkwrm
8 years ago

We’re going to pay cash for a house with our refund/entitlement. We live in a depressed area and can buy a habitable one for cheap. When you are living hand to mouth, having a house nobody can take away is a pretty desirable thing.

Bridget
Bridget
8 years ago

I really like this post, though I won’t be following all of it =( I’m putting the bulk of my income tax return against my student loan and then the rest I’m going to use to save for a vacation to Africa in July.

Sara
Sara
8 years ago
Reply to  Bridget

Actually, it sounds like you are doing 2 and 5 ๐Ÿ™‚ Good for you — hope you enjoy your travels!

Rachel
Rachel
8 years ago

If you negotiate your debt down (or effectively cancel a portion of your debt)I would think that would result in taxable income. Granted, the tax on that income would be less than the debt cancelled so you would save some money, but not 100% of amount of debt written off. You should probably expect a 1099-c from the credit card company next year.

partgypsy
partgypsy
8 years ago
Reply to  Rachel

Is that so? that doesn’t make sense to me.

bkwrm
bkwrm
8 years ago
Reply to  Rachel

I think in a lot of cases it is considered income.

Tyler@Debt Reckoning
8 years ago

This is good advice. I treat the occasional refund like I do all unexpected windfalls – I put the money to use in some way that it earns a return. I add a little to a dividend stock position, or pay some down on the mortgage, or take a class or certification to build my resume (or just to expand on something I want to learn – such as mechanics, etc.).

Grad Student
Grad Student
8 years ago

I deposit the money in my bank account when I get it and do nothing differently afterwards.

Jaime
Jaime
8 years ago

This has nothing to do with the original post, but I’m curious with how JD is doing with his war on stuff?

JD has often talked how he’d like to move into his own “dream” apartment and start over, so I’m wondering if he’s now following that wish at his new place?

Its been awhile since we’ve had an update on his war on stuff. =)

Joanna
Joanna
8 years ago
Reply to  Jaime

Well according to a recent post, now that he’s in his own apartment, he finds that he needed some of that stuff he took for granted. Wine opener?

Jay
Jay
8 years ago

Peoples’ first idea is always to spend it. Sitting on it is certainly better than spanking it all on stuff you wouldn’t of normally bought, but for me investing or a high interest savings account rule supreme for tax refunds.

Dan
Dan
8 years ago

I prefer to owe money, as long as I can pay it ๐Ÿ™‚ The first year I got married, I had a *huge* refund. Like $5k. Believe it or not, I was on pins and needles waiting for that huge sum of cash. I couldn’t wait to get my W2’s fast enough (I usually run a quick check in August, so I knew I was in for a big one), I couldn’t get my other tax docs fast enough, I couldn’t file fast enough, and then there’s the nervousness that I put the wrong bank account number in and that… Read more »

Ely
Ely
8 years ago

REFUND /= RETURN.

It’s correct in the title, but wrong several times in the article. The RETURN is the form you send in to the IRS. The REFUND is the money you get back.
Yes I know it’s not important, but isn’t tax time confusing enough already?

Heather
Heather
8 years ago

My and my partner’s refunds are 1) filling out our emergency fund ($1500 instead of the $1000+debt payoff that’s usually suggested, because I’m unemployed and Partner has a variable income); 2) a car maintenance issue I should have dealt with over a year ago and forgot about. And then there’s nothing left. That being said, we may have an emergency on the horizon (moving 3 hours away to care for a suddenly-ill parent), so it’s important to max out the EFund rather than pay off a debt like I’d prefer. The “up side?” to this emergency is that it will… Read more »

EconomicallyHumble.com
EconomicallyHumble.com
8 years ago

Great tips! My tax refund should be decent, especially since this year I’m again deducting my school and work expenses. I’ll likely put half of whatever I get into savings and the other half to my highest interest rate student loan.

frugalportland
frugalportland
8 years ago

On the one hand, I’m psyched, thrilled, ecstatic that my tax refund will wipe out my credit card debt. On the other hand, I wish that money had been more available during the year.

Kristin Turberville Haffey
Kristin Turberville Haffey
8 years ago

I just forwarded this link to my husband — it was neat to see that our planning is really close to this guide, eventhough we didn’t know about it beforehand. Thank you! (and I think it’s funny…one of my “if-can-have-a-little-left-to-get-something-for-myself” items is underware, too…lol…)

ps — that bike is AWESOME!!!

Ruth H.
Ruth H.
7 years ago

This is a really helpful post–thanks for sharing such valuable financial tips. I tend to go to extremes with my tax refunds: I either spend all of it to pay off a credit card bill, or I throw all caution to the winds and go on a shopping spree. Perhaps I need to find a happy medium. I love your “spend 5% on something nice” rule–what a great compromise!

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