Tax Refund? How You Use It Says a Lot About You

Getting a tax refund this year? Roughly 70% of American taxpayers will receive a refund this year at an average of around $3000. If you’re in the majority getting cash back this year, this refund isn’t a windfall but money you earned and lent interest-free to the government over the last year. That comes out to roughly $250 a month you should have gotten but didn’t. What will you do with it now? Spend it, save it, invest it? Maybe you’ve already spent it before it came! What you actually do with it says a lot about you.

Good Intentions vs. Actual Spending

If you read the news, you’ll find that most surveys show that Americans plan on spending their refunds wisely by paying down debt and putting the money into savings, retirement or investment accounts. That sounds awesome and it could be. However, this is planned spending for the 50% that have decided how they’re going to spend it. And as we know, the best of intentions often get derailed. Some surveys show that while most Americans plan on putting that tax refund to paying off debt (62%), they also plan to use it toward everyday spending (36%), home improvement projects (19%), major investments like a car or home (17%), self-care (16%) and shopping sprees (11%). Travel gets anywhere from 6% to 11% of respondents depending on the survey.

As a majority of Americans live paycheck to paycheck and a $1000 emergency will put most in debt, I don’t think these surveys hold much water. Clearly Americans are not using their refunds effectively year to year. Better surveys would ask how Americans actually spent their last refund and how much went to these categories.

Surprisingly though, few accessible surveys are done on how Americans actually spend their refunds and those paint a different picture than planned spending about debt or savings. The surprise finding of research on actual refund spending? Health care is the top expenditure for tax refunds across all income brackets. In fact, health care spending rises 60% immediately in the week following, according to a recent study. Out-of-pocket medical expenses on debit cards increased 83% following a tax refund check. That said, trying to ferret out how Americans actually spend their tax refunds across all spending categories is like diving into a black hole – the information is crazily hard to find.

All you get are aspirational spending plans.

Anecdotal Evidence We are a Nation of Spendthrifts

In everyday conversations with people at work or with family or friends or others, I’ve rarely heard the brave soul who says they will spend their tax refund on paying down debt. Fewer still are the faint voices of those putting the money into investments or retirement accounts. Instead, I hear “that’s our vacation money” or “it’s the down payment for a car” or “shopping.” Others have already bought consumer goods or pampered themselves before they’ve even gotten the check and are impatiently waiting so they can pay it off. Maybe this counts toward the survey results for “paying down debt”? Sadly, most of these people complain about being strapped for cash and feeling pinched at every angle.

This is just anecdotal evidence that we can’t handle our finances but the stats back me up.

How to Be Savvy and Become Financially Free

Research on everyday millionaires, such as that done in The Millionaire Next Door and other places, shows that the self-made individual is frugal and spends time not just planning their financial steps, but executing on them. Financially stable people do this, not just the wealthy. Are you part of the paycheck to paycheck crowd or the group that puts money away?

Here are 5 ways the financially savvy use their refunds.

  1. Pay down their highest debt – whether this is highest totalled debt or highest interest-bearing debt
  2. Invest it toward retirement.
  3. Put it toward money-making investments such as stocks, bonds, peer-to-peer loans, passive income generation, self-business, royalties and licensing, and rental income
  4. Pay down their mortgage for a reduction in overall interest and time left on the mortgage.
  5. Investing in their own future by acquiring new skills and abilities that earn more.

And by use, this means the entire or majority of their refund, not just an extra $100 to credit cards and the rest on travel, shopping, etc.

Not a Windfall

Tax refunds, as mentioned before, are money we earned last year but didn’t see included in our take home pay. If we’re needing those paychecks to save us, then that just shows we didn’t use our money wisely last year. Same if we’re looking to splurge with it. There are exceptions but again the stats back me up on this.

From CNBC  article on millennial spending habits

It’s easy to see how we live paycheck to paycheck when non-essential spending totals $838 per month for millennials, $588 for Gen Xers, and $683 for baby boomers.

What am I getting at? Well, that we have a hyperconsumptive culture and a spending problem. People can claim they’re being financially pinched all they want but having $588 to $838 a month in disposable income as shown above isn’t being pinched. It’s just more evidence of a problem no one likes to admit they have.

How people spend their tax refunds will show where on the scale they fall.

The Way Out of Financial Jeopardy and to Financial Freedom

For most people, spending an entire tax refund on paying off debt sounds nice in theory, horrible in practice. They might spend some but not all. How people actually spend their refunds is unknown since little hard data exists that is easily accessible. But here’s a rubric that I find useful in my own spending and it’s called the 70/30 Rule.

The 70/30 Rule states: live on 70% of your net income and invest the remaining 30% in money-making activities. Caveat, if your debt payments exceed 35% of your net income, use some of the 30% to pay it down.

This rule is golden because it straddles the line between living like a miser and living like a spend thrift. You can use that 70% however you like – concerts, travel, shopping, etc. in addition to your basic needs like food, shelter, utilities. Have a drug problem? Fine, include it in the 70% (please don’t have a drug problem). That 30% though will go toward investments that make you money, whether that’s a business enterprise or traditional investments like stocks and bonds.

This split, though, allows you to enjoy your money and the fruits of your labor no matter your tax bracket but still be responsible enough to provide for emergencies and your retirement. And this isn’t limited to a dollar amount. As your income increases or decreases, the dollar numbers for spending and investing change while the percentages stay the same. It’s the way to live within your means and know what those means actually are by putting a percent value on them.

For those of us truly serious about financial freedom? Increase that investment percent to as much as possible once your living needs are covered. This is pretty much what I did to semi-retire in less than 10 years. You can do it too. Start valuing frugality and stability. Once you do that, spending impulses begin to ease.

Next Year’s Tax Refund

Chances are that if you get a tax refund this year, you’ll get one next year as well. That’s a year away though. Why not take this year to get your spending and investing habits in order? Start living the 70/30 Rule today so that when your tax return rolls around, you can spend 70% and invest 30% without guilt or regret – while being legitimately responsible at the same time. That’s true financial stability.

Like this article? Share it so that others can learn these financial secrets and start living their best lives now.

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