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Getting a Tax Refund? Here Are Five Smart Ways to Use It.

Key Points
  • A tax refund—while nice to get—isn't really extra money. It's money you earned that you didn't have the use of during the year.

  • A refund means you had too much money withheld from your paycheck, and, in effect, gave Uncle Sam an interest-free loan with money that could have been in your own pocket.

  • Now you need to decide how to use this money wisely—and make sure you don't overpay next year.

Dear Readers,

The new tax law has caused a lot of confusion about tax refunds. On the one hand, early filing data indicated smaller refunds, but then a February 28th Treasury Department report stated that four weeks into the filing season, refunds were actually up 1.3 percent over last year.

But whether your own refund is larger or smaller this year, to me the underlying question is whether getting a tax refund is fundamentally a good thing. Of course, I understand that a lot of people look forward to getting a refund. Getting money rather than shelling it out always feels like a plus. But look a little closer. If you're getting a refund, the fact is that you had too much withheld and overpaid your taxes during the previous year. In other words, you gave Uncle Sam an interest-free loan with money that could have been in your own pocket.

Looked at this way, a tax refund—while nice to get—isn't really extra money. It's money you earned that you couldn’t use during the year. Does this perspective change the way you regard your refund? Will it change the way you use it?

Five smart ways to use your tax refund

You may consider your refund a windfall or you might see it as hard-earned cash. Either way, while it's tempting to blow it on an extra, I suggest that you put the majority of it to your larger financial goals. Of course, that doesn't mean you can't have some fun, too. 

To maximize your refund, here are five suggestions I'd put at the top of the list.

  1. Pay down debt—Are you carrying credit card balances? Do you have a car loan? This type of expensive, non-deductible consumer debt—considered "bad" debt—is best to get rid of as soon as possible. If you have that type of debt under control but are struggling to pay off student loans, this could be a perfect time to make an extra payment or two. While a student loan generally falls in the "good" debt category, getting out of debt completely can be a positive goal that will free up future money for other uses.
  2. Add to your emergency fund—It's always hard to put money aside for a hypothetical like an emergency when there are so many other concrete obligations, but you'll thank yourself if you're ever in a bind. Don't let something like a layoff or health problems totally derail your financial plans. If you haven't started an emergency fund, do it now. Or add to an existing one. To be safe, you should try to keep enough cash to cover three to six months of essential expenses in an easily accessible account, like a savings account.
  3. Boost your retirement savings—You can do this a couple different ways. For most, increasing the amount you are contributing to an employer-sponsored retirement plan is the way to go. It’s quick and easy. Remember, if you’re eligible for an employer match, the match is the minimum you should contribute. But you can (and probably should) do more. In 2019, you can contribute $19,000 to a 401(k) or 403(b) plan ($25,000 if you’re 50 or older). If you don't have access to a retirement plan at work consider opening an IRA now. An IRA can be a great way to build retirement savings. You can currently contribute up to $6,000 yearly ($7,000 if you're 50 or older). If you qualify for a Roth IRA, consider starting there—especially if you're in your early earning years.
  4. Contribute to an HSA—With healthcare costs a universal worry, contributing to a health savings account (HSA) can be a great way to plan ahead. To open an HSA, you have to have a high-deductible health insurance policy. Check with your insurer to see if you qualify. The benefit of an HSA is that you get an upfront tax deduction for the contribution. Plus, withdrawals for qualified medical expenses are tax-free. On top of that, any account balance continues to grow tax-free year after year and can be used for healthcare expenses later on in retirement. Most HSA plans provide investment options, so you can invest your HSA in different investment options like you can in an IRA or 401(k).
  5. Treat yourself—No matter what practical use you have for your refund, it’s okay to set aside a little to treat yourself and your family. But make it something you really want, perhaps something you'd already started to save for. Remember, this is money you've earned. Think of it as a reward for your efforts.

Change your withholding—and your attitude

If you didn't review your withholding last year, put it high on your list of to do's so you're ready for 2019 taxes. The IRS withholding calculator can help you do a quick "paycheck checkup." You may also want to consult with your tax advisor. If you need to make a change, you can download a new Form W-4 and complete and submit it to your employer.

Remember, the ideal is not to under or over pay Uncle Sam. With that in mind for next year, you won't be disappointed if you don't get a big refund. Rather, you'll be happy you're smart enough to only pay the taxes you owe.

 

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.

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The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager. 

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