How to Maximize Your Tax Refund

by Gary Foreman

How to Maximize Your Tax Refund photo

Don’t waste that tax refund. Use these guidelines to determine how to best maximize your tax refund and put that money to work for you.

Dear Dollar Stretcher,
As tax season approaches we are anxious to get that large tax check. As usual, we have it spent before it gets here. There are so many things we need. My washer and dryer are approaching their end, the car has a leak in the radiator. Then there is the desire for a vacation.

I know that it would please our creditors to just plunk down the tax check in their lap. There won’t be enough to pay all of them. But when that money is gone, what do we do to buy the high-dollar items that we need? Would it really help to use maybe $1,000 or so of the tax check on one of the loans? Should we use it on the highest interest loan?

What you do with the tax refund may be less important than what you do with your bills and expenses

Cathy asks a good question. While it’s tempting to use a tax refund to treat yourself to some special purchase, in many cases it’s more important to use the money to pay off bills or make necessary purchases.

The honest answer to the question is – it depends. What you do with the tax refund may be less important than what you do with the other bills and expenses that you face.

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Using your tax refund to reduce debt

Using a $1,000 tax refund to pay off your credit card could save you $180 a year (assuming 18% interest rate). So if you’re able to keep the balance down, you’d save that much every year for the rest of your life. (See The Best Credit Card Debt Repayment Options for Different Credit Scores.)

But if you then have to use the card for an auto repair or other purchase soon after, you could end up with the same credit card balance that you started with or more. In that case, you really haven’t accomplished anything.

You can gain an advantage by using the refund to pay down the account that’s charging you the highest rate of interest. Then put new purchases on the card that’s charging you the lowest rate of interest.

You should always be trying to move your debts to the lowest cost credit card. It may not seem like much, but if you have a $7,000 balance and can reduce your rate from 18% to 13%, you’ll save $350 each year. You can compare balance transfer cards here.

Spending your tax refund

What happens if you spend the refund? Again, it depends on what you buy and how you buy it.

Anyone who is married with children can appreciate the desire for a vacation with your spouse. But, you might be better off planning a date night once each month.

What about the auto repairs or a new washer and dryer? You could visit your mechanic and have him install a new radiator. An alternative would be to have your spouse or a neighbor install a radiator purchased at a junkyard. That could reduce the cost of the repair by 50% or more.

It’s possible that the IRS refund could give you some buying leverage. Take the washer and dryer for instance. If you wait until they break, you’ll probably be forced to buy immediately. Having the refund check available means that you’re a ‘cash’ buyer. That could allow you to drive a better bargain. It would also allow you to look for a good used deal in the paper. (See 5 Tips to Negotiate a Better Deal…On Anything.)

Another possibility would be to save the old washer and dryer. Perhaps a $100 service call would buy some time.

The trick is not to use the refund to momentarily feel wealthy and pay retail. Use it to give you flexibility to make it go further.

Perhaps the best way to maximize your tax refund

There’s still one other option for your tax refund. You could use the money for a cash emergency fund.

In most cases it would be silly to keep an emergency fund that earns money market rates (less than 1%) while she’s still paying credit card debts at 18%. But, if Cathy could learn to face emergencies without using her charge cards, it could be worth it.

Generally, once a family begins to put big expenses on their credit card they’ll always carry a balance.

Build an Emergency Fund

With these simple tips and tools, you can build an emergency fund, even while living paycheck to paycheck.

Two final thoughts. Part of every monthly budget should be money set aside for medical, home and auto bills. It might not be easy setting aside $100 or more each month. But it’s essential. You might want to find a part-time job that could generate that much.

You may also want to have your withholding changed. Remember that the IRS doesn’t pay you interest on your withheld taxes. So instead of getting a big refund each year, you could use the extra take home pay to reduce those 18% card balances each month.

Reviewed January 2022

About the Author

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, and You can read Gary's full bio here. Gary shares his philosophy of money here. Gary is available for audio, video or print interviews.

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