When you get a large tax refund, it can be tempting to splurge on something big and fun, like a Caribbean vacation. However, a large tax refund is actually a great chance to improve your current financial situation, and splurging on a luxurious vacation could squander that opportunity.
Here are nine ways you shouldn't spend your tax refund—and what to do with that money instead.
Don’t Spend It on Material Things
When you have a large sum of money coming in, it can be tempting and splurge on a television, gaming system, or clothing, but these items aren't a good investment. They don't have a lasting positive financial impact. Putting it simply, splurging this way is effectively blowing a lot of money on material items that won't improve your financial situation. The items will depreciate over time, you won't earn money from them, and you'll likely have to replace them a few years down the road.
Don’t Hit Up the Casino
You may be tempted to take your tax return to your local casino. Since it's money that you didn't expect to have, it can be easy to justify gambling with it for the chance to win even more money.
From a financial standpoint, this is a terrible idea because gambling has no guaranteed rate of return. In fact, the odds are heavily stacked against you. You'd be better off putting that money in the stock market. It'll still give you the thrill of the unknown, but, depending on what you invest in, you could have much better odds of receiving a return.
Don’t Just Put It in Your Checking Account
If you just put the refund money in your checking account, you may slowly spend it without even realizing it. Suddenly, it becomes easier to justify the extra meal out or the quick shopping trip because you see that your account has plenty of cash.
It's better to set that money aside and earmark it for a specific purpose. If you're not sure what to do with the money yet, then put it in your savings account. Savings accounts have two advantages over checking accounts: they usually earn better interest, and they're usually harder to dip into, so you'll be less tempted to spend the funds frivolously.
Don’t Spend It All on Your Kids
It may be tempting to hand out a large amount of money to each of your children. While it's fine to spend some money on them, buying everyone a new iPhone or taking them on a huge shopping spree will not help you reach your goals. It can also set expectations too high for your children, and they may begin to expect more money from you. If you really want to spend the money on your children, then consider setting up a 529 college savings account for them instead.
Don’t Use It as a Down Payment on a Car You Can’t Afford
It can be tempting to use your refund as a larger-than-usual down payment to help you purchase a car that you normally wouldn't be able to afford. If you need a car, look for one that you can afford to pay off in three years, and one you would've been able to afford without the tax refund windfall. You can even try to pay for a car in cash and use the refund as the beginning of your savings for a new car.
Don’t Borrow Against It
If you go to a tax preparation store or business, they may offer you a refund anticipation loan or a rapid refund option. These loans usually have extremely high interest rates and application fees.
When you file your taxes, you can file electronically and have the money directly deposited into your account. Often, the amount of time it will take to get your refund is not that much longer than it would take to get one of these loans. In other words, when you take a refund anticipation loan, you end up losing money just to get your money a little faster. Plus, if your refund is less than expected, you will be stuck paying back that money with interest.
Don’t Continue the Debt Cycle
It's a great idea to pay off your credit cards with your tax refund, but it won't help you if you then run up your credit card balances again in the following months. To help prevent that, put a portion of your refund away for an emergency fund before you pay off your debt.
Don't Book an Expensive Vacation
Planning a getaway with your tax refund isn't the worst idea, but you don't have to choose the most expensive option or spend your entire refund (or even more). There are plenty of ways to save on travel, and many involve simply avoiding common and costly travel mistakes. By planning out a trip well ahead of time, you'll save money, have more time to research the best way to enjoy your time abroad, and be less likely to overspend as the tax refund hits your bank account.
Don't Buy Unneeded Items
When you get a large tax refund, you may be tempted to splurge and get yourself something nice that you wouldn't normally buy before the refund—something that you don't really need, but crave. It's wiser to spend money on items that you truly need or will help you save money in the long run. For example, you could buy a coffee or espresso maker to replace your daily trip to the coffee shop, or you could buy a bike to save on work commute costs.
Treating yourself is not totally out of the question, but try to limit this to around 5% to 10% of your refund.
What You Should Do With Your Refund
When you get your tax refund, you need to make a plan for that money. This plan could mean that you put some toward your debt, build up your emergency fund, or save towards your child's college education.
If you just put it in the bank, without a purpose, you will be surprised at how quickly that money can disappear. Take the time before you get your refund to determine the best way to spend it. Figure out if you need to catch up on your bills or if you have a specific goal, like saving for a down payment on a home.
Determine how you want to spend it and then shop around for the best price on the item you'd like to purchase. This price comparison will make the most of the money on whatever you decide to do with it.
In general, the key is to think carefully about how you'll spend the money long before you have it. Impulse purchases are rarely the best in the long-term, so instead, plan out your spending ahead of time in a more rational state of mind.
Take the Time to Adjust Your Withholdings
If you're getting a huge refund each year, it may be time to adjust your tax allowances. The IRS has a withholding calculator that you can use to determine the amount you should claim on your taxes. Check with your state to see if it has a similar calculator that you can use.
If you adjust your withholdings, you may have more money throughout the year to reach your other financial goals, such as buying a home or paying for your child's education.