What to Do With an Income Tax Refund

According to the IRS, more than 70% of taxpayers receive an income tax refund. Would you believe that the average refund is expected to be in the neighborhood of $2,800 this year? That’s a big chunk of change! In this post I’ll help you make the most of your refund from Uncle Sam.

How to Get Your Tax Refund the Fastest

Ok, let’s talk refunds. First, a bit of surprising news: getting a large tax refund isn’t necessarily a good thing.  What it usually means is that you overpaid on taxes during the year and now the government needs to settle with you.  You can find out more about this, and how to pay the right amount of taxes, in my episode on reducing your taxes.  But if you are expecting a tax refund, you obviously want to get it as quickly as possible. That way, you can put it to work for you sooner rather than later. The fastest and safest way to get your tax refund is to submit your return online, using e-file. I’ll tell you more about how e-file works in just a moment.

If you e-file and request a direct deposit, you’ll probably receive your funds in less than ten days. But if you submit a paper return and request a direct deposit or a paper check it could take several weeks longer. Plus you run the risk that your tax form(s) or refund check could get lost or stolen. If you don’t receive your refund, it’s important that you make an inquiry about it using the IRS Refund Status Tool.

How File Your Tax Return Electronically

There are three ways to file your tax return electronically:

1. Use your own tax software. Most tax programs include the option to submit your return by e-file.

2. Use a tax preparer. You can find an authorized e-file tax professional by clicking through a link on the IRS home page at irs.gov and entering your zip code.

3. Use “Free File” at the IRS website. You’ll find it at irs gov freefile.

If you or your family’s adjusted gross income is less than $57,000 in 2009, you qualify for Traditional Free File, which is the IRS’s free online tax preparation software. It takes you step-by-step through a series of questions and completes your tax form(s) with the data you input.

If your adjusted gross income is more than $57,000, you can still submit your return online at the IRS site using the Free File Fillable Forms, which are blank electronic versions of the paper forms. You’ll have to choose the appropriate form and fill it out yourself—without the help of software. That means you’ll need to pay close attention and double check your math.

How to Find Tax Help

If you have questions and need assistance with your tax return, you can find free help at a local IRS Taxpayer Assistance Center. Go to irs.gov for those locations and their business hours. Low and moderate-income taxpayers may qualify for free tax preparation services through volunteer programs in many communities. Find out more at the IRS website (irs.gov) or by calling 800-TAX-FORM (800-829-3676).

What To Do With Your Tax Refund

Once you receive your refund, there are a gazillion things you can do with it. Taking a vacation, going on a shopping spree, and buying expensive bottles of wine immediately come to mind, but I bet you won’t be surprised if I tell you that the best thing you can do with the money is to save it. It might not be as much fun as many other options, but it will certainly go a long way towards improving your personal finances. Here are my recommendations for what to do with your tax refund in the order of priority:

1. Add it to your emergency fund. One of the most important defenses you have against unexpected expenses or the loss of income is a cushy emergency fund equal to at least six months worth of your living expenses. If you don’t have a reserve fund or if it’s not as big as it should be, make sure that’s the number one priority for your tax refund! 

2. Purchase health insurance. If you don’t have health insurance, consider using your tax refund to pay premiums for an affordable policy, such as a high-deductible plan. That’s the kind of policy that also gives you the ability to open up a tax-advantaged Health Savings Account.

3. Pay down high-interest debt. If you have at least a few months worth of living expenses saved in an emergency fund, but also have expensive consumer debt like credit cards, retail store cards, or payday loans, use your tax refund to pay them down.

4. Fund an IRA. If you don’t have an IRA, which stands for Individual Retirement Arrangement, use your tax refund to start one. You can contribute up to $5,000 to an IRA in 2010, or $6,000 if you’re age 50 or older. Be aware that there are tax penalties for withdrawing money from a retirement account before the age of 59½. So be sure to put money in an IRA only after you’ve established an emergency fund and are sure you won’t need the money.

5. Fund a 529 Education Savings Account. If you’re saving money for your own education or that of a child’s, consider putting your tax refund in a 529 plan. Funds in a 529 grow completely tax-free if you spend them on qualified education expenses. You can learn more about 529s in one of my previous posts and at SavingForCollege.com.

More Quick and Dirty Tax Refund Tips

 You can even opt to split up your refund and have it automatically deposited into multiple financial accounts, like an IRA and a savings account, using IRS Form 8888. If you just want to have the money sent to one account, simply use the direct deposit line that’s on the regular tax form.

An important quick and dirty tip is that if you consistently get big tax refunds each year, you probably need to adjust your withholding so less tax will be deducted from your paychecks. Use the IRS Withholding Calculator to help you complete a new Form W-4 and submit it to your employer. Remember that it’s not a good idea to use a tax return as a forced savings plan—it’s better to pay yourself first with higher paychecks throughout the year. That way you can save the amount you’d otherwise be paying to the government and make interest on it, instead of loaning it to Uncle Sam for free.

Money Girl’s 10 Steps to a Debt Free Life

I want to thank everyone who’s downloaded my newest audiobook, Money Girl’s 10 Steps to a Debt Free Life. Learn how easy it is to get out of debt and stay out of debt for good. You’ll find out which debts to pay off first, when to refinance, how to raise your credit score, cut costs, and lots more. Take control of your finances and create a more secure future. Get your copy of Money Girl’s 10 Steps to a Debt Free Life today at Audible.com or in the iTunes store.

More Resources:

Frequently Asked Questions about Splitting Federal Income Tax Refunds
Form 8888, Direct Deposit of Refund to More Than One Account
“Where’s My Refund?”
Free File
IRS Publication 910, Guide to Free Tax Services
Ten Ways the IRS Can Help You in Person

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