Best Ways to Spend Your Tax Return

The big financial question for America over the next few months is: How should I spend my tax refund?

The Internal Revenue Service says most of you – somewhere between 75 and 80 percent – are getting one. The average tax refund in 2015 is going to be around $3,539. The IRS knows this because it handed out $26.8 billion in refunds to 7.6 million people the first 11 days of tax season.

That is a financial windfall for anyone, but especially the half of American families who live on less than $53,046 a year, the median household income in the United States. For most of those people, a tax refund that big represents more than a month’s worth of take-home pay and all it takes to get it is filing a tax return.

So what is the best thing to do with all that money?

“The people for whom the refund is a significant amount of income should think carefully about how it is used,” Dr. Jonathan Parker, a professor at MIT’s Sloan School of Management, told Debt.org. “Sometimes the best thing is to use it right away on needed purchases like replacing car that is breaking down or replacing a dying furnace.

“If you don’t have an immediate need, the best bet is to use your refund to reduce or eliminate debt, especially credit card debt.”

Credit card debt has re-emerged as a drag on the U.S. economy. The Federal Reserve says credit card debt is up $91 billion from September 2011 to the end of 2014 and now stands at $882 billion.

The average family household owes $5,700 on credit cards. Those who carry a balance from month-to-month owe even more, $7,743. That much debt creates a lot of stress and there is no better stress reliever than firing a $3,539 shot at the bottom line.

The math behind applying your refund to credit card debt is fairly simple. The average interest rate on credit cards is 15 percent. The average credit card balance for a household is $5,700. If you make the minimum payment each month (1 percent of principle, plus the interest), that comes to $128 a month.

At $128 a month, it would take five and a half years to pay off the balance and cost you $2,681 in interest.

However, if you apply the $3,539 tax refund to the $5,700 you owe – and still pay only $128 a month – you would have it paid off in 20 months and the interest would amount to just $281.

Right there, you’ve saved almost four years of payments and $2,400 … and you’re out of credit card debt!

Unfortunately, the practical use of tax refunds is more of a theory than a practice in a lot of households.

“There is a spike in spending when a refund check arrives,” Parker said. “Weekly spending goes up the first week, especially in households with low income and very few assets.”

Surveys show that 91 percent of people say they will use the refund to reduce debt or put into savings, but at least half spend the money shortly after receiving it and not on a needed or required purchase. They view a refund as “free money,” an unexpected bonus check from Uncle Sam that they can spend as they like.

A new computer, big-screen TV or home theatre is a lot more fun use of the $3,539 that suddenly appears in your bank account, but .it won’t provide you any help with credit card debt.

“Think carefully about what you want to accomplish with the tax refund and be sure you end up doing what you planned,” says Parker.

Author

Bill Fay
Staff Writer

Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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