How to decide whether to spend or save your tax refund

Ahead of Tax Day, the IRS has issued more than 70 million refunds, at an average of $3,256.

That’s over $400 more than last year, when the average refund was just above $2,800.

For many Americans, a lump-sum payment of this size is rare and it’s tempting to squander it.

Still, a growing number of tax filers — now 46% — plan to save their refunds, according to a LendingTree survey, up from 41% last year and 40% in 2020. Roughly 16% said they plan to book a trip or splurge.

“It’s tempting to go on a spending spree after the tax season, but do not think of a refund automatically as ‘free money’ that you can use for mindless purchases,” said Simon Zhen, chief research analyst for MyBankTracker.

“Using a tax refund toward improving your financial situation is a good decision that can ultimately save money later.”

In order to make the most of that money, Peter Casciotta, executive director of Asset Management & Advisory Services in Cape Coral, Florida, offers these tips for deciding whether to put those funds toward savings rather than a vacation or new exercise equipment.

If you’re a taxpayer who has limited to no debt, a sufficient emergency fund and your retirement savings is on track to hit your goals by your retirement date, then you can spend your tax refund, Casciotta said.

Most financial experts recommend having at least six months’ worth of expenses set aside in an emergency fund or more if you are the sole breadwinner in your family or in business for yourself.

If you already have a decent emergency fund, then consider your retirement savings, said Rita Assaf, vice president of retirement leadership at Fidelity Investments.

Are you saving enough for your eventual retirement? The odds are you probably aren’t.

There are a few simple rules of thumb, such as stashing 10 times your income by retirement age, although experts recommend using a retirement calculator to get a more accurate picture of how much you’ll need in your golden years.

You should be saving your tax refund if you are financially unprepared for emergencies or have a need for necessary household items, have multiple lines of credit or little to no retirement savings, according to Casciotta.

More than one-third, or 34%, of households have less in emergency savings now than they did before the pandemic, according to Bankrate.com.

The Covid crisis has also set retirement savers back, while low interest rates, higher inflation and ongoing market volatility are posing problems for long-term financial security.

Assaf recommends contributing at least enough to your workplace retirement account to take full advantage of the employer match or, if possible, the maximum amount workers under age 50 can put in, which is now $20,500 in 2022.

If you can afford even more, Assaf recommends contributing to both a 401(k) and an individual retirement account. You can set up direct deposit into either a traditional IRA or Roth IRA account and contribute up to $6,000 in total. Generally, traditional IRAs are most effective if you expect to be in a lower tax bracket when you retire, while Roth IRAs are best for those in a lower tax bracket today.

Another option is to put the money toward your children’s future.

Many 529 college savings plans offer tax benefits that are better than using a simple savings account.

You get a tax deduction or credit for contributions, and currently 34 states and the District of Columbia offer a direct state tax deduction for your contributions. In addition, earnings grow on a tax-advantaged basis and, when you withdraw the money, it is tax-free if the funds are used for qualified education expenses such as tuition, fees, books, and room and board.

Even if you aren’t fully prepared for emergencies, but have no debt and solid retirement savings built up, you could both spend and save a portion of your tax refund.

“They should use a percentage of the refund to create an emergency fund and use the rest to spend on something that makes them happy,” said Casciotta.

“People who can spend and save their refund are in the best position possible.”