The 7 worst ways Americans are using their tax refunds5 min read
Because of COVID-19, this year’s tax deadline got delayed three months to July 15. But even with the extra time, it appears many people are still waiting until the last minute to file — including many taxpayers who will be receiving refunds.
The IRS says that as of July 3, it processed 95 million refunds, down from 105 million by the same time last year.
The tax agency says Americans are getting back an average $2,762 this year, slightly more than during the 2019 tax season.
With the economy struggling and unemployment still high, managing a refund wisely is more important than ever. But many Americans aren’t making the best use of their windfalls.
See the seven worst ways people are using their tax refunds.
1. Letting it rot in checking accounts
Setting a tax refund aside in an emergency fund is smart. Many financial advisers recommend keeping enough cash on hand to cover at least six months’ worth of a household’s regular expenses.
But here’s what’s not so smart: dumping the money into a checking account.
Traditional checking accounts pay interest that ranges from puny all the way down to 0%. When a person lets a refund stagnate in a checking account, that’s squandering the earnings potential of that cash.
The best place to build an emergency fund is in a high-yield savings account. That way, the money will have a chance to grow, so there’ll be more of it available when it’s needed most.
2. Going on spending sprees
As many stores and shopping malls have reopened, Americans have been tempted to stretch their legs and engage in a bit of tax-refund-sponsored retail therapy.
But the job market is still shaky, especially as some states and cities now go back into lockdown. A gigantic new TV isn’t much comfort when a family finds itself straining to make ends meet.
Building up emergency savings should be a first priority for using tax refund money, to protect against a sudden financial downturn.
But if your emergency fund is set and you feel you can afford to treat yourself, be sure to use a cash-back card so you’ll get something in return for your splurging.
Cash back doesn’t come only from credit cards these days. There are now cash-back debit cards that will earn you up to 10% back every time you shop at your favorite stores.
3. Dropping it all on debt
Although using a tax refund to help pay off debt is normally a wise strategy, this year is a bit different.
A tax refund can and should be put toward other uses instead, because many financial institutions are offering relief during the pandemic. They’re allowing customers to defer debt payments and interest.
For example, anyone with debt from a federal student loan can skip payments until Sept. 30. The government also is waiving interest until then.
Borrowers with student loans from private lenders will probably still have to pay — but might be able to save some money by refinancing.
It’s simple and free to compare student loan refinancing options online, to find a better rate that can bring down the monthly payment.
4. Not thinking about the family’s future
When you think of all the things a tax refund might be spent on, life insurance might be pretty low on the list. But as the events of this year have shown, some things are out of our control. A person should be as prepared as possible for whatever comes.
Yet nearly half of Americans (46%) have no life insurance, according to a 2020 study from the industry group LIMRA.
Buying a life insurance policy is the easiest way for a breadwinner to provide financial protection for his or her family, in case the worst happens.
Contrary to popular belief, getting insurance isn’t a long, complicated process. In less than two minutes, you can gather multiple offers online, all tailored to fit your family’s needs.
Depending on your health and age, you could get $1 million in coverage for as little as a dollar a day. In terms of bang for your buck, life insurance could very well be the very best use of a tax refund.
5. Using the money to buy a new car
With gas prices so low, now might seem like the perfect time to put a new vehicle in the driveway and cruise around in the reduced traffic of the coronavirus era.
But even though the “free money” from a tax refund can allow Americans to make larger-than-usual down payments on their dream rides, those new vehicles plummet in value the second they’re driven off the lot.
An owner won’t get nearly as much back if financial circumstances change and a car has to be re-sold within months.
It’s better to buy an affordable pre-owned car that won’t suck up an entire tax retund, particularly since there are other expenses to consider — like car insurance.
If you decide to go the used-car route and need some coverage, use a free service online that will help you compare rates from multiple insurers. Shop around and see who’s offering the best deal before you settle on a policy.
6. They neglect retirement planning
The economic turmoil caused by the pandemic has had a profound impact on Americans’ retirement funds. Many who are nearing their golden years have seen their investments shrink over the past few months.
But some people nearing retirement with cracked nest eggs are using their tax refunds for immediate spending, not putting the money into their retirement funds.
Saving the money for when you retire is a sound choice, no matter your age. If your retirement is a long way off, you’ll thank yourself later if you put a portion of your tax refund into an account where it will earn returns.
Balancing today’s needs with the future can be difficult, so you might want to consider recruiting a certified financial planner to help you set and reach your long-term financial goals.
Some financial planners operate entirely online, so you’ll be able to prepare for your retirement without ever having to put on a mask or leave the house.
7. They make bad bets
Casinos across the country are finally up and running after months on ice, and some people will hope to double their tax refund at the tables. But the odds of that aren’t good.
A smarter way to experience that kind of thrill is to invest in the stock market.
The current explosion of coronavirus cases has shaken the financial markets, meaning some high-profile stocks are available at discounted prices. But investors need to thoroughly research any company before buying in.
If you’re playing the long game, look at solid dividend-earning stocks or stable ETFs (exchange-traded funds) to build your portfolio.
Even if you don’t have much experience investing, you can use a robo-advisor to manage your investments for you and make the process stress-free.
Your robo-advisor will automatically update your portfolio whenever there’s a market shift. Once you’ve chosen the risk level you’re comfortable with, you can just sit back and watch your money grow.