Should You Spend or Save Your Tax Refund?

By Frank Byrt

According to the American Institute of CPAs' (AICPA) annual survey to determine Americans' top financial concerns and assess their financial well-being, taxpayers say they're likely to use their tax refund conservatively – to build up savings, pay for day-to-day household expenses, or put toward debt. 
 
And a conservative approach is just what CPAs and financial advisors are recommending to their clients.
 

Using Your Tax Refund Wisely

The AICPA National CPA Financial Literacy Commission offers the following tips for taxpayers receiving a refund: 

Prioritize. When contemplating how to allocate your tax refund, remember this hierarchy: (1) basics, (2) emergencies, (3) debt. If you're struggling to cover basics, such as food, shelter, or health care, then you should put your tax refund toward those needs first. If you're covered there, then put the money in your emergency fund. Having cash available to cover unanticipated expenses should be a top priority. 
 
Make a split. Those with credit card debt are sometimes eager to put all their tax refund money toward the balance. But there's a better way. Split the money between your emergency fund and your credit card bill. This way you reduce your liabilities and have cash on hand for life's unexpected expenses, so you don't have to take on more debt. 
 
Tackle high interest. Pay the credit card balance or other debt with the highest interest rate first. The faster you can attack debt with the highest cost, the further you can stretch your dollars in your quest to be debt free.
 
Look long term. There's sometimes a tendency to use tax refunds for big splurges. If you're lucky enough to have a healthy emergency fund and no credit card debt, consider using your refund to make an extra mortgage payment or a contribution to a retirement account to benefit your future.
 
Last year the average individual refund was $2,860, and through March 22 this year, it's $2,827, according to the IRS. 
 
Ernie Almonte, CPA, CEO of Almonte Group LLC, and chair of the AICPA's National CPA Financial Literacy Commission, told AccountingWEB that of the 78 percent of individual taxpayers expecting a federal refund this year, 46 percent said they'll use it to add to their savings, 37 percent say they'll use it for day-to-day household expenses, and 33 percent plan to use it to pay down debt.
 
The survey found that 43 percent of those who expect to receive a refund consider it more important to their financial well-being this year than in years past. In part, that may be because workers saw their paychecks shrink in January as a payroll tax cut expired, returning Social Security withholding to 6.2 percent from 4.2 percent and effectively reducing take-home pay for most workers by 2 percent, the AICPA said.
 
According to survey results, 71 percent of taxpayers said they've felt at least some impact from the paycheck reduction, and 96 percent of those people said they've made some kind of adjustment in their spending because of it, including:
  • 70 percent will put less in their emergency fund.
  • 51 percent will cut back on cable and digital entertainment. 
  • 45 percent will contribute less to their retirement account.
  • 17 percent will skip payments on credit cards, utilities, rent, or mortgages.
In order of priority, Almonte tells clients who are receiving a refund to: 
  1. Set aside money for immediate household expenses.
  2. Build up an emergency fund to cover at least six months of expenses.
  3. Set aside some of the money for a retirement fund.
  4. Pay down credit card debt.
When his clients are expecting a sizeable refund – on the order of the $2,800 the IRS is reporting as average – Almonte said he tells them to change their withholding tax deduction to reduce that, because it doesn't make sense to have the government holding your money for months when it can be put to immediate use by the taxpayer. "You shouldn't be getting refunds that large."
 
Scott Halliwell, a certified financial planner for USAA, a financial services company that serves US military veterans and their families, told AccountingWEB he recommends that those getting sizeable refunds use 10 to 15 percent of it to "buy something nice." He said many people look at their refund as some sort of windfall and are tempted to spend most of it, so after permitting themselves some sort of reward, it's not as challenging to allocate the balance toward more prudent ends.
 
Building an emergency fund that covers three to six months of expenses also should be a priority; however, that's a tough recommendation to get people to comply with, even though it's the best way to avoid going into expensive debt at the time of a financial crisis, Halliwell said. After that, he advises clients to pay down consumer debt, given the relatively high interest rates on credit cards. 
 
The telephone survey was conducted among 1,011 US adults between March 14 and March 17 for the AICPA by Harris Interactive for National Financial Capability Month.
 
Related articles: 
 

Already a member? log in here.

Editor's Choice