By Andrew Housser
The Internal Revenue Service (IRS) issued more than 59 million refund checks last year for a total of $174.4 billion. The average tax refund was close to $3,000. For two-thirds of taxpayers, that is more than a month's worth of income, or three months of groceries for the average family of four. It might seem like "free money," but remember: a tax refund is money that you earned throughout the year.
Although it may be tempting to spend these returned dollars frivolously, the smart move is to treat a refund check like a normal paycheck. That means assessing your personal financial situation and taking certain actions -- such as the ones suggested here -- to put the money to good use.
Pay down debt. More than 40 percent of tax filers use their refunds to pay off credit cards and other loans. This is wise. A $3,000 tax refund can cut almost one-third of a consumer's average credit card debt. Paying down debt makes more money available each month to put towards savings. It also reduces the amount of interest you owe and leads to a smaller minimum payment. All of these measures can lead to a higher credit score, which boosts your chances of getting better rates for auto loans and mortgages.
Bolster your savings. About a quarter of Americans put at least some of their refund money into savings. You should have at least six months of monthly income set aside for emergencies. If you are not close to this amount -- or do not even have an emergency fund -- consider setting some or all of your refund aside in a savings account.
Invest in your own future. Put the money towards starting your own business or taking vocational training or college classes to further your career.
Invest in your children's future. Open or add to a 529 college savings plan to help pay for your children's future education. Future withdrawals to pay qualified educational expenses are free from federal income tax.
Save for retirement. Start or contribute to an existing individual retirement account (IRA) or add funds to a 401(k) plan. You may be able to double your investment if your employer matches your contribution.
Maintain your vehicle. Unexpected automobile repairs can hit the wallet hard. Visit a trusted mechanic for an assessment of your car's road-worthiness and make necessary repairs. Now is also a good time to set aside money for costly expenses like new tires.
Get healthy. Use the funds to pay for expenses that health insurance may not cover, such as new eyeglasses, braces for your kids or alternative treatments like massage therapy. You also could join a health club, hire a personal trainer or buy new bikes for the family to encourage outdoor activities.
Invest in your home. If you have an adjustable-rate or high interest mortgage (and plan to be in your home for at least a few more years), consider refinancing while rates are still low. Put the tax refund money toward paying closing costs and fees. By refinancing, you may be able to save thousands of dollars per year on mortgage interest. Another option is to complete a home improvement project such as a kitchen renovation or installation of energy-efficient new windows. These can make your living experience more enjoyable, as well as increase the resale value of your home.
Determining how best to spend this so-called windfall is a good "problem" to have. However, a large refund is an indication that too much is being withheld from your paycheck during the year. In effect, you have allowed the government to hold on to your money interest-free. It is much better that you have the cash in hand throughout the year to put toward savings and debt reduction. Ideally, your goal should be to break even with the IRS. To ensure that happens, review your W4 form and use the IRS Withholding Calculator to adjust your federal income tax withholding allowances if need be – a move that will put more money in your paycheck throughout the year.
Andrew Housser is a co-founder and CEO of Bills.com, a free one-stop online portal where consumers can educate themselves about personal finance issues and compare financial products and services. He also is co-CEO of Freedom Financial Network, LLC providing comprehensive consumer credit advocacy and debt relief services. Housser holds a Master of Business Administration degree from Stanford University and Bachelor of Arts degree from Dartmouth College.