Each year, the majority of people who file a tax return wind up with money back from the IRS. And getting that lump sum of cash can easily open the door to temptation, whether it's springing for a new gadget or taking the vacation you've been longing for. But before you blow that pile of money, consider the ways it could help improve your finances -- that's certainly what a large chunk of Americans are doing.
Put your tax refund to work
In a recent Offers.com survey, 21% of respondents plan to put their tax refund directly into savings. Meanwhile, 20% say they'll use that money to pay off debt. By contrast, only 5% plan to spend a refund on travel, while just 4% think they'll splurge on a purchase that's otherwise outside their budget.
If you're behind on emergency savings, it absolutely pays to use that money to boost your cash reserves. How do you know if you're behind? As a general rule, you should have enough money in the bank to cover a minimum of three months of living expenses. And for better protection, it helps to aim for more like six months' worth of bills in savings. If your current balance is nowhere close, then it pays to stash your tax refund in the bank.
Meanwhile, if you're currently carrying debt other than a mortgage or auto loan, it pays to use your tax refund to knock it out. This especially holds true if you owe money on credit cards, because those balances could cost you a boatload in interest.
What if you're good on emergency savings and don't have any unhealthy debt? Are you then free to blow your refund on whatever you want?
Not so fast.
If you're behind on retirement savings, for example, then using that money to beef up your IRA or 401(k) is a smart move. Ideally, you should be setting aside 15% of your earnings or more for the future, so if you're unable to do that based on your regular income, you should, at the very least, use your tax refund to get closer.
Meanwhile, if you're behind on saving for other important goals, like your kids' college or the home you're trying to buy, then your tax refund can help you catch up. And if you have an expensive but essential expense you've been putting off due to a lack of funds, like a key piece of furniture for your home or a household repair, then you're better off spending your refund on that than using it for something fun but unnecessary.
Remember, a tax refund isn't free money; it's money you earned but never collected in your paychecks. As such, it really pays to make the most of it. While indulging in a much-wanted vacation or splurging on electronics or apparel may seem appealing, in the long run, you'll be better off using that refund responsibly -- especially since you're not guaranteed to get one year after year.