How to Spend Your Tax Return

How To Spend Your Tax Return

Welcome to tax season or at least the early innings of tax season. A time when many US households find themselves with some extra money, if not, a windfall.

This time of year you need only to bend your ears to hear all the fabulous things people are going to do with this “windfall” of cash. “I am going to buy a new flat screen television:”  “I am going to go on a vacation to Mexico” “I am going to remodel my kitchen.”


Here is the sad truth. This was your money all along, withheld from you paycheck, and given back to you some months later. This money comes out of your paycheck under the line on your pay stub titled Federal Withholding. The US Internal Revenue Service holds this money interest free until you file taxes and then in most cases, the money returns to you in a lump sum. Notice I said interest free. This is not a good deal for you. Yet Americans go wild for this money. Tax return money ends up being a huge boost to the economy because the propensity of lower-income families to spend the money is so high.

Social Experiment

If you gave me $500 to hold for you for ten months and at the end of ten months I gave you $500 dollars back, would you think of this as a free money. Probably not.- The Smart Fi


How To Spend Your Tax Return

The title of this blog post is really just a joke. I don’t want you to spend your tax return at all. I want you to follow these 3 steps to find the best way to put your tax return money to work for you. Let me help you to move along the path to financial independence. Isn’t that the whole point of this blog?

Triage for your tax return money

  1. Do you have high interest consumer debt? This would be debt like, credit cards, high interest student loans, or high interest auto loans. The home mortgage does not fall into this category. My idea of high interest is somewhere in the range of 8% or higher. Any money “spent” towards this high interest debt gives you an automatic return on your money equal to the interest you were paying. So if you put $1000 towards a credit card charging 18% interest, you are getting a guaranteed return on investment of 18%. That is hard to beat.
  2. Do you have an emergency fund? This would be a small amount of money that is liquid. In this case, the definition of liquid, would be easily accessible cash money that you could get your hands on quickly for emergency expenses. Emergency money is most commonly kept in a savings account at your bank or an online bank. I use Capital One 360 online bank. The current interest rate for my online savings account is 1.3%. The general rule of thumb is you should have 3-6 months of emergency money available to you. I keep three months worth of expenses in my emergency funds. Notice I said expenses and not earnings. This is an important distinction. Add up all of your monthly bills such as mortgage, auto and food expenses. This should give you a rough idea of how much you spend in a month. If you were to lose your job, you only need to cover the monthly expenses not monthly income, to get you to the point when you find a new job.
  3. Contribute to your Roth IRA or 401K. If you have made it this far along in the triage process you are doing well. You have no high interest consumer debt and you have a 3-6 month emergency fund. Now it is time to start making your money work for you. You are ready to invest.  If you do not have a Roth IRA, now is a good time to open one with your tax refund. You can click here to read my post on why you need a Roth IRA. My two favorite places to open a Roth IRA are Charles Schwab and Vanguard. If you have less than a $1000, Charles Schwab is probably better because the minimum initial investment amounts are smaller at Schwab. You can’t go wrong with either brokerage. Next log into you work 401k and increase your contribution amount to capture the employer match. Now, this is very important. It is becoming more common for 401k’s to have an auto escalate feature. This means you set your contribution percentage to increase at a predetermined interval automatically. For example, you could set your contribution percentage to auto increase 1% per year. I have helped many people set up their 403b’s at work and most people just blow past this awesome feature. Making increases automatic will give you the “set it and forget it approach.” And really who will notice 1% missing from their paycheck. Financial planners often recommend saving 15% of your income into these types of tax advantaged accounts. To that I say, blow up the conventional wisdom and try to get to a point where you are saving at least 20% of your income.
  4. Save for your children’s college. If you are already saving 20% of your household income you could use your tax return money to open a 529 college savings plan. These are tax advantaged accounts for the purpose of setting aside money for future college expenses. My two favorite 529’s are the Utah plan and the Nevada plan. Both are low fee plans, run by Vanguard. I have not fully funded college for my two children but I have a plan in my head for how to make it happen. I will save the details of that plan for another blog post.
  5. Pay off mortgage debt. This is the last step in the tax return triage. If you made it this far you are in great shape. You now have a high quality problem, paying off low-interest debt. At this point you have no high interest debt, you have an emergency fund, you are saving 20% of income, and you have a 529 college savings account. This is the step that I am on. I relish the day I can write my last check to the mortgage company. Until that day comes, this is where I will “spend” my tax return money.

This year, when your tax return money arrives in you checking account. avoid the urge to spend. Follow this 5 step triage guide to make your tax return money work for you and progress towards financial freedom.

What do you think? What step are you on? Please take a minute and leave a comment. If you like my blog and want new posts delivered directly to your email inbox, subscribe to the email list on the home page. No Spam, I promise.


12 thoughts on “How to Spend Your Tax Return

  1. I love this! I just recently adjusted my W4 so I can quit lending my money out interest free. Funny how long I did that… Now I plan to put my money to work on debt pay down and opening a 529. I sorta feel like a responsible adult!

    1. I truly believe progress and or change does not happen in one fell swoop. It is the aggregation of many small marginal gains. You are definitely making progress. Keep up the good work. By the way I really liked your blog Broke at 40.

  2. Hi there! Great article. I’m new to investing and this may be a stupid question, so bear with me.
    I am a bit confused on adding more money to the 401k or IRA before say, your own investment account. I’ve seen this advice other places as well so I’m starting to think I may be missing something. Since you can’t get that money out of 401ks or IRAs until you are “retirement age” without huge tax penalty, is investing in your own investment account better (in a FI sense) so you could collect the dividends?
    Thanks so much for your article and help!

    1. There is rule 72t click here to see the details from Investopedia. Also with a Roth IRA, you can withdraw your contributions (not earnings) from the account without penalty. In my opinion, the tax advantages are just too great to pass up the tax-advantaged accounts like a 401K or Roth IRA. Plus never miss out on an employer match if that is available. After I max out my 401K and Roth IRA each year then I split any additional investments between paying down mortgage and taxable investing. In my taxable investing account the drag of taxes is heavy. All dividends are taxed each year, and any earning will be taxed as capital gains. I hope that helped. If you have any more questions you can reach me on twitter at @ThesmartFi and by email at

  3. For some reason, I still enjoy getting a tax return even though it would be more advantageous to not have a tax return and give an interest-free loan to the government. Must be a psychological thing to have a ‘windfall’!

    1. That’s a tough decision there. Up to this point, I have focused on retirement savings and mortgage paydown. But as both of my boys get older, I realize I am getting behind on college savings. I know I am going to retire, but I don’t know if my boys will go to college. That is the thought that runs through my head.

  4. While I understand that it would be better if I had to pay a little than get money back, I find it easier to get money back. It’s just easier on the budget. I do prefer to get as little back as possible, though.

    1. Thanks Joe for the comment. Most of the feedback from the article has been similar to yours. Most people seem to prefer a small return as opposed to a small amount owed.I can’t say I disagree.

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