5 Worst and Best Ways to Use a Tax Refund

by Nancy Zambell | April 6, 2012 2:00 pm

My parents were working people, with five children (deductions!), which meant they received a nice little check each year after filing their taxes. They didn’t have the benefit of a good tax adviser and didn’t understand that it was their money that Uncle Sam was returning to them, year-after-year. In fact, they were giving the U.S. government a tax-free loan!

Imagine what that $1,000 or so they received, annually, could have turned into had they been putting it away, instead of being so generous to Uncle Sam.

But that was then, and my folks weren’t any different than most people on our block. But in today’s world, with so much good (and often no-cost) advice, there’s almost no excuse for letting Uncle Sam have free use of your money. All it takes is a little calculation to determine how much less you should be paying in throughout the year so that you just about break even by Dec. 31.

For many people, it’s this simple: Let’s say you’re getting about $1,000 back every year from your tax refund. Divide that by 12, and you get $83.33 — the amount you should reduce your paid-in taxes by each month. Just call your payroll department, and they’ll give you the right form to do that. Wouldn’t it be better to have that $83.33 in your pocket, instead of lending it to the government each month?

That’s a great strategy for 2012. But if you’re expecting a refund from your 2011 taxes, let’s look at the worst and best ways to spend that windfall:

 The 5 Worst Things to Do With Your Tax Refund

  1. Put it in your checking account, and spend it on a lot of little things. If you do that, you won’t have any idea where your money went.
  2. Go to Las Vegas or buy a lot of lottery tickets, to “leverage” your refund into bigger winnings. Bad idea. Need I say more?
  3. Use it for a down payment for something you should pay cash for (like a vacation, furniture, or swimming pool), and then taking on a financial obligation that you don’t need (exceptions: houses or cars).
  4. Lend it to a relative or friend. Consider those loans as gifts, because, chances are you won’t get your money back.
  5. Spend it all on a luxury vacation (unless you normally take luxury vacations and don’t have any other financial obligations).

Instead of wasting your refund, consider putting it to good use in the following ways:

The 5 Best Things to do with your Tax Refund

  1. Fund a six-month emergency stash. The challenging economy of the last few years took its toll on many folks, but those with an rainy-day fund fared much better than those who were already living paycheck-to-paycheck.
  2. Fund an IRA. If you don’t already have one, this would be a great start. If you’re under age 50, most folks can contribute up to $5,000 this year; over age 50, the “catch-up” contribution rises to $6,000. No matter your age, if you’re still working, saving for retirement is the one of the very best things you can do with any “windfall.”
  3. Start your own business. According to the Kauffman Foundation, more than 543,000 new businesses were created in 2011. If you’ve always wanted to have your own company, the improving economic period we’re in right now is the prime time to begin. If you can’t afford to do it full-time, start out slow.
  4. Invest. If you’re a beginner, start with an exchange-traded fund or a mutual fund. If you currently invest, put more money to work in your existing holdings or supplement your portfolio with some new additions.
  5. Start a 529 (college-investment plan) for your children or young relatives. I did this with my nieces and nephew when they were born, and so far, two out of the three have used the money to help fund their college years.

These are hardly the only great ideas for getting the most from your tax refund, but they’re my favorites. Bottom line — don’t waste the money. And for 2012, change your deductions so that you can turn that extra money in your paycheck into a greater stockpile each and every year — a seed that can grow into a worry-free retirement.

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