It is NOT winning some sort of income tax lottery, nor is your Uncle Sam sending you some special “government money”. It is simply a refund. Because you overpaid your taxes, the government, after keeping your money all year long, is giving it back to you.
What should you do with it?
It depends, but answering the following questions will establish your priorities:
Are you behind on any payments?
If so, get caught up with any and all creditors. One caveat: if your debt has been turned over to a collection agency, you should try to settle the debt. Many will agree to accept a fraction of the original debt. Just make sure you don’t send them any money until you have a letter from them stating that the agreed to payment will “settle the debt in full”. And make sure you understand the best ways to send money when you do make that payment.
Do you have any insurance payments or property taxes that will need to be paid?
If you don’t have the money already set aside, then put your refund where you won’t touch it and obligate it for those payments.
Do you have debt?
Using the refund to pay off debt (other than mortgage debt) is a great thing to do with your refund. Paying off a 20% interest rate credit card is the same as earning a 20% return on your money. Using all of your refund on debt reduction might not be exciting, but will give you a great feeling of knowing you are closer to being debt free.
How big is your emergency fund?
If you have no debt other than your house, you should consider adding to your emergency fund until you have at least six months of expenses saved up. If you were to get injured or lose your job unexpectedly, that emergency fund will serve you well.
Are you investing enough for retirement?
Assuming you have no debt except your house, and that you have six months of expenses set aside for emergencies, you might want to use your refund to boost your retirement investments. However, because you are doing so well with your finances, you might want to use some of the refund to have fun with. Enjoy!
Why should you lose it?
I am not talking about literally losing the money, but I do think you should lose the practice of getting that big refund.
Think about it: the government has been using your money all year for free. If you get an average refund ($2831 so far this year), you could be taking home an extra $225 a month instead. This is money you could be using to stay current on debt, pay extra on debt, build your emergency fund or invest more for retirement. If you have been getting close to the same refund year after year, you need to adjust your W-4 to start getting less refund and more take home pay.
Unless you are willing to create a budget and live on it, the extra money each month will disappear. In that case, you would be better off letting the government keep it for you than wondering what happened to it.