A tax refund isn't free money.
You didn't just walk down the street and have a tax refund drop into your lap. You selected the amount you wanted withheld, it turned out to be more than you would've paid in taxes and now you have it back. It's still money you've earned, and it's still money that can go to toward just about any purpose you'd like.
The IRS expects more than 70% of taxpayers to get tax refunds this year. Last year, 111 million refunds were issued, with an average refund of $2,860. That's about 111 million people whose grumpy uncles told them they were "giving the government a free loan," but that's also a whole lot of taxpayers who were handed a lump-sump paycheck all at once.
So what do you do with all that money once you've let Uncle Sam have it for safe keeping? Well, according to a Bankrate.com report, just 6% of you say you've going to splurge on a vacation or shopping spree. Given that the last recession was recent enough for people to still feel a bit guilty about conspicuous spending, we're thinking the "spend it" response is a bit muted.
Conversely, the folks who says they're going to save or invest it (34%), spend it on necessities such as food or utility bills (29%) or pay down debt (27%) may not be telling the whole truth, either. According to finance site NerdWallet, the average U.S. worker saves just around $2,500 a year. If the average refund is $2,860, people are either not saving it or they're letting the bulk of it serve as their entire year's savings.
According to Bankrate, approximately half (47%) of all taxpayers anticipate a refund this year. The percentage is highest among Millennials (66%) and drops to 49% of Gen Xers, 34% of Baby Boomers and 26% of older generations. Overall, about 1 in 4 American adults had already filed their 2016 tax returns by mid-February, with nearly 2 out of 3 early filers having already received a refund or are expecting one.
"Millennials are actually the age group most likely to have already filed their 2016 returns, and the age group most likely to save or invest their refund," said Sarah Berger, The Cashlorette at Bankrate. "This shows a sense of responsibility and overall financial savviness among young adults. They're setting up a solid foundation for their future financial selves. It can be tempting to splurge with that refund, but saving it is so much smarter; consider it an investment in yourself."
Last year, Capital One took a more nuanced approach to tax refunds after finding that 12% of all taxpayers consider their refund free money that they can splurge with. Though 61% said they spent their last tax refund on things they needed, that same percentage said they preferred doing so to saving for later. So not only were they not saving, but 49% didn't feel great about it afterward and 23% wish they could've spent their refund on things they wanted instead.
While splurging doesn't build off of your witheld windfall, neither does using your tax return as a bridge payment for necessities. If you're counting on it to pay bills, you should either adjust your witholding to get access to that money more quickly or start saving more effectively. As the folks at NerdWallet point out, the average $3,071 refund received by people they surveyed can earn an extra $34 a year in interest if you just park it in a savings account with a 1% yield. However, if you add it to your average $2,500 a year in savings, the nearly $5,600 you have on hand should be enough to cover most emergencies. It's more than enough to cover the $2,650 price of a new transmission for your vehicle, the $1,944 cost of a new hot water heater, the $1,900 annual cost of ongoing home maintenance or the $1,700 cost of and emergency room visit.
What it won't cover, however, is the nearly $11,000 average cost of brief unemployment. For that, NerdWallet credit and banking expert says Sean McQuay recommends stashing the equivalent of at least three months' income in an emergency fund. Meanwhile, if you have debt or if you're behind on your retirement savings, a tax refund can help address those issues as well.
"What helps me the most is setting specific goals for my savings," McQuay says. "I don't want to have to go into credit card debt if something unexpected comes up."
James Capolongo, head of consumer deposit products at TD Bank, notes that the simple act of putting a windfall like a tax refund directly into an account where it can earn interest and grow is typically the hardest part. However, keeping that cash out of sight and out of mind is all-important if you plan to save now and play later.
"While it's always wise to save a cash windfall, like your bonus, it's ok to reward yourself for your hard work every now and again," Capolongo says. "Consider automatically depositing a small amount of money into your savings so you can spend a little something on yourself like that new mobile phone or day trip to the ski slope without any buyer's remorse when your credit card bill comes."
Editors' pick: Originally published March 16.