Many people dread tax season. But for some, one beneficial byproduct of this annual responsibility is getting your hard-earned money back in the form of a tax refund. If you receive a tax refund this year, here’s what you should know.
What is a tax refund?
A tax refund isn’t just a bonus check from the government. It's simply the IRS returning your own money to you.
When you get a refund, it indicates that you overpaid your taxes throughout the year. This also means that the amount of money you received in your paychecks was smaller than it could have been.
It’s important to find a balance when it comes to your taxes, and while some people withhold taxes on their own, many have their employers withhold taxes for them. Ideally, you want to maximize your take-home pay throughout the year while sending just enough to the IRS to cover your actual tax bill.
How should you allocate your tax refund?
Once a refund hits your account, you might have the urge to use it up. So how should you plan to allocate the money in a responsible way?
To avoid an “all or nothing” mindset about your tax refund, it’s wise to make a plan ahead of time. Instead of spending it all or saving it all, consider a bucketing approach. The first bucket should be savings, putting 50% of your tax refund away immediately. The next 30% can be put toward paying down debt. The final 20% could be used on
spending for wants.
The main takeaway is to strategize ahead of time. If money goes into your bank account and you don’t have a plan, you might find yourself forgoing your savings and debt reduction goals.
How can I maximize the impact of my tax refund?
A helpful way to identify where money should go is to think about the best use of the next dollar you have. This will provide a lot of clarity, and it will focus your attention on what’s giving you the most financial stress.
If that stress is centered on savings, focus on the short term and make sure that you have 3-6 months of emergency funds available. After that, you can start to focus on long-term savings, such as a down payment on a house or specific retirement goals.
If debt is the primary source of your financial stress, focus on the lowest balance first or the debt with the highest interest rate. This approach will help with debt reduction momentum and financial stability, and provide you with more peace of mind.
For more advice on navigating your refund this tax season, set up a call with a Wealthquest financial advisor.
Stay tuned for next month’s Money Monday!
This week’s edition of Money Monday comes from Megan Hammann, CFP®, CMAA, CEPA®, Director of Financial Planning at WealthQuest.
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