What should I do with my tax refund?

Tax time is a special time of year in that it forces us (at least those of us who do our own tax returns!) to take a look at our finances. We submitted our own returns last month, and have just received the refunds. But no matter the outcome – tax refund or tax bill – tax time can be full of pressure – and communication problems.

If you end up owing the tax office money, it can be a time of unexpected financial pressure.
One year, after some additional income, I was surprised to find my estimated return came out at $600. But no matter how long I waited, the promised sum did not arrive in my bank account. It was only when a bill arrived in the mail that I discovered I had misread the estimate. It was an estimated ‘return’ of -$600. Yes, with a minus sign. The linguistic framing ‘return’ had caused my brain to gloss over this very important symbol.

If you end up getting a refund from the tax office, there’s a different kind of pressure – that of decision making.
One of the first posts on Enrichmentality considered the example of a couple, Abby and Bobby, who have just gotten an unexpectedly large tax refund. Abby wants to save the money, Bobby wants to spend it.

In that post, on the taboo of money, we look at why Abby and Bobby have these contrasting views. But in today’s post, I want to look at something slightly different – how we frame our tax returns.

What is framing?

Framing refers to how we – as individuals and as groups and societies – perceive and communicate about reality.

The different way sin which the same facts are presented to us can make us feel very differently about the same scenario.

To use an example from Zweig in The Intelligent Investor we’ve looked at before:

If someone offers you a 90% chance of success, ask yourself whether you’d be happy with a 10% chance of failure.
Although the risk is exactly the same, you may find yourself reacting differently.

So how does this relate to taxes?

Some people view tax refunds as ‘free money’ or an ‘unexpected windfall’. But really, it is just a matter of receiving a portion of your income back which was incorrectly taxed in the first place.

Take, for example, my situation in the 2016/2017 tax year. I started the tax year off by receiving my final payment from my former employer before my resignation took place. I was taxed at the usual rate, which assumed that I would maintain this level of income throughout the year. But I did not. So when it came to tax time, I received the a portion of the tax back that had been taken from me based on this incorrect (but fair) assumption that I would continue to earn at a level that would involve a higher tax rate.

If you frame a tax refund as getting your own money back, I think it’s much easier to make ‘sensible’ decisions than it is when you view it as ‘free money’. You worked hard for that $100 or $1000 or whatever your refund is. Now you want it to work hard for you.

What is a sensible decision?

That will really depend on your personal circumstance. If you have debts, like a mortgage, it might be paying that off. Otherwise, it might be saved towards a holiday, rather than taking a vacation on credit.

If you’re used to spending your tax refund like it’s ‘free money’, or if you and your partner can’t agree, perhaps you can spend part of your refund on something fun, and part on something that will guarantee future fun – after all, slogging away at a mortgage for decades on end, being in debt due to a health crisis, or retiring uncomfortably certainly aren’t fun.

You work hard for your money - and for your tax refund.Have you gotten a tax refund this year? What will you spend it on? Let me know in the comments!

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Today’s featured image is from our first stop on our 2016-2017 big holiday – Fiji!

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