Spend, save or invest? How to get the most mileage out of your tax refund

Soon after Jan. 31, the deadline for employers to mail out W-2s or 1099s, the signs start to spring up everywhere: "Spend your tax refund here!"

Many people file as soon as they receive those tax documents, and start looking forward to spending that refund.

"I believe when most people think about their income tax refund, they think buying a new vehicle or going on a shopping spree ... and simply just spending their bonus as fast as possible," says JP Thompson, founding partner at Thompson Financial Advisors in Cape Girardeau.

But before that money burns a hole in your pocket, give a little thought to other options.

"For some reason or another, I feel like most people don't view this refund as a chance to gain leverage for their future," Thompson says.

There's nothing wrong with splurging a little, but try to keep in mind that the extra cash is an opportunity to shore up your savings.

"Don't get me wrong, I'm all for balance, so take a portion of that money and pursue a well-deserved gift or a relaxing vacation, but with the majority of that money, put it back for your future self to enjoy," Thompson says. "Enjoy your refund, but spend and save it wisely."

Some people have trouble saving throughout the year, so they earmark their refund money for a specific use.

"I do have some clients who use it as a forced savings plan," says Catherine White, a partner at Begley, Young, Unterriener & White LLC in Cape Girardeau.

Experts agree it's better to save at least part of the refund, or put it to a use that will help your overall financial situation.

Catherine White, a CPA and partner at Begley, Young, Unterreiner & White, sorts through files at her desk.Glenn Landberg

"Consider applying it to the things that you felt unable to do throughout the year as a result of having too much tax withheld," says Tyler Cuba, managing partner at Cuba Financial Group in Cape Girardeau. "What to do with your refund depends. This may include saving into a traditional or Roth IRA, applying it to your student loan or other debt, adding to your short-term savings, or using it as a down payment on a larger purchase."

A tax refund is just that: a refund of money that taxpayers have overpaid during the year.

"When you have too much tax withheld from your paycheck, your net income is reduced, essentially allowing the government to hold this money until you file your taxes," Cuba says. "In any case, it is important to understand that a tax refund is a return of money that is already yours."

White says she believes the best option is not to get a refund at all and just spend the money as it is earned, instead of having it withheld by the IRS.

"It's basically giving the IRS an interest-free loan," she says. "Financially, it's not the smartest thing."

While some people use their tax refunds to pay down credit card debt, White says it's better to have less money withheld so there's more money during the year to pay credit card bills as they come in and avoid interest payments. That way, you not only put the money to work for you as you earn it, but you can save on other expenses, like late payments and penalties.

Cuba agrees it's a decision that should be made thoughtfully.

"The choice becomes whether or not you choose to use it when you earn it, or wait until your taxes are filed to receive a refund of the amount you overpaid," he says.

There's an easy way to figure out the amount of withholding taxes on the IRS website at www.IRS.gov. Taxpayers can view a withholding table on the site that can be used to make a decision about a person's filing status, based on information about the taxpayer's situation and income.

"It's probably a good idea to do it every year, because your personal situation can change," White says.

Having money withheld throughout the year and cashing it in when taxes are filed also can be downright risky, especially in view of the uptick of identity thefts.

White says a dozen of her firm's clients discovered that someone else had used their Social Security number and had gotten their refunds.

In a case like that there is myriad paperwork, affidavits and police reports to be garnered before the IRS can sort out the mess and issue the refund to the correct person, a process that can take 10 months or more.

"You'll still get the refund, but it will take a long time," White says.