Much has been written about average 2022 tax refunds being smaller than those received by taxpayers in 2020 and 2021. Some taxpayers who previously received refunds could even have a tax bill. Reasons include:
- No above-the-line tax deduction (i.e., deduction from gross income to calculate adjusted gross income or AGI) for charitable contributions made by non-itemizers
- No federal economic impact (stimulus) payments made via income tax credits
- The child tax credit returned to its 2019 level of $2,000 for children under age 17
- The earned income tax credit and child and dependent care expense tax credit also returned to 2019 levels
- Unusually large mutual fund distributions were made by investment companies in 2022
- Taxpayers did not adjust tax withholding from previous years
Any refund is better than none, however, and still reserves thoughtful consideration. Below are five smart uses for tax refunds for Extension educators:
- Debt Repayment- There is probably no better “investment” than repaying consumer debt (e.g., outstanding credit card bills). Paying off an 18% credit card is equivalent to earning a 20.5% return for taxpayers in the 12% tax bracket (18 divided by 1-.12 (.88) = 20.5). They would have to earn 20.5% to keep 18% after taxes. Unlike stock and mutual fund investments, the amount earned by repaying debt is guaranteed and tax-free.
- Emergency Fund- A commonly recommended amount is a nest egg of three months expenses but any amount of savings is better than none. After multiple rounds of Federal Reserve interest rate increases, many online banks are currently paying 3.3% to 4%+ on savings and money market accounts.
- Investments- Those with no outstanding debt and adequate emergency reserves might consider investing their tax refund. They could use it to purchase paper I-bonds currently paying 6.89% or explore stocks, mutual funds, or exchange-traded funds. With an 8% return, money will double in nine years, according to The Rule of 72. At the end of 20 years, a one-time $1,000 investment will grow to $4,660.
- Retirement Savings- Use your tax refund to fund a traditional and/or Roth individual retirement account (IRA). The maximum annual contribution allowed in 2023 is $6,500 under age 50 and $7,500 at age 50+. Minimum contributions are set by IRA custodians.
- Human Capital- Another good option for tax refunds is to invest in yourself or, as economists like to say, “build your human capital” by taking a college course or other job training experience to improve your knowledge and skills. Additional education could eventually lead to a raise or promotion and pay back tuition expenses many times over.
Written by Barbara O’Neill and Martie Gillen
Edited by Kristen Jowers