How Should You ‘Spend’ Your Tax Refund

April Client Letter: How Should You ‘Spend’ Your Tax Refund

Are you getting a tax refund this year? Plenty of folks are. Much like trivia, running through the IRS data is always interesting…at least for those who love diving into the minutiae. So here are some tax facts for the 2022 season:

• Through March 25, 2022, the IRS has received over 81 million returns and processed just under 79 million returns.
• Roughly half the returns were delivered by tax professionals and the remainder were self-prepared.
• So far, the IRS has sent out almost 58 million refunds checks totaling $188.7 billion. The average tax refund is $3,263, which is 12.4% above a year ago. It’s a pretty good chunk of change for the average person.

While we would counsel against an interest-free loan to the federal government, some folks like what might be called “forced savings.”

But, getting back to our title, how might you best “spend” your lump sum. Maybe a better question we can ask is how might you best “invest” your cash windfall?

Not everyone will receive a refund or a large check from the IRS. But ideas we’ll put forth can be used when receiving any gift, bonus, or unexpected cash windfall.

Before we dive in, we want to quickly add: If your children, a relative or close friend has talked about their refund, feel free to forward our suggestions to them.

7 smart ways to invest your tax refund

1. Do you have a rainy-day fund? Is if fully funded? You understand the importance of reserves. Whether it’s a home repair, auto repair, a layoff or unexpected bill, having cash set aside will ease the financial burden.

We recommend three to six months of readily accessible savings in the event of an emergency. If you don’t have a rainy-day fund, don’t procrastinate; get started today.

2. Get out of debt. Years ago, I saw a quote that went something like this. “The road to poverty is paved by high interest rates.” I don’t know who coined the phrase, but many people run up high-rate debts and struggle to pay them off.

Pay down or pay off high-rate credit cards or unsecured loans. You might start off with the card with the lowest balance first. Wiping the slate clean on a card or cards is a big psychological win and will encourage you to stay in the battle until you are out of debt.

3. Tackle your student loans. Can the president simply wave his hand and forgive your student loans? If he could (and maybe he can; the jury’s still out on this one), would you receive a 1099 for debt that’s forgiven (the devil is always in the details)? Or, for that matter, should you wait for the bureaucracy to solve your problem?

If you have an emergency fund and credit card debts are paid off, consider tackling your student loans. Sure, they helped you get through college, but they are a burden hanging over your financial future.

4. We reap what we sow. If you don’t sow into a retirement plan, there will be no harvest come retirement. For example, if you take the hypothetical $3,263 tax refund and stash it in a Roth IRA, you’ll have $32,834 in 30 years, assuming an 8% annual return. Plus, you’ll pay no federal income tax when you take a qualified withdrawal from a Roth IRA.

At 10%, you’ll have $56,937, and at 6%, you’ll have $18,741. Of course, returns aren’t guaranteed and may vary, but trading one’s natural inclination for instant gratification for a future payoff can pay you a handsome reward.

Disclosures: The hypothetical example is provided for illustrative purposes only. It is not a prediction or guarantee of actual results, nor does it intend to represent the performance of any specific investment. It is not intended to illustrate the performance of any specific product. It does not reflect any charges, fees, taxes or other expenses which would cause actual performance to be lower.

Contributions to a Roth IRA are subject to income limitations. You may take nontaxable withdrawals from a Roth IRA if you are at least 59 ½ and the account has been held at least 5 years. Otherwise, earnings withdrawn may be subject to ordinary income tax and a 10% penalty.

5. Invest in the future of your child, grandchild or yourself. There are various options, and we can point you in the right direction to help get your started.

You might consider an education savings account of a 529 plan for your kids. While you won’t get a tax deduction for contributions into the accounts, these vehicles allow you to grow the nest egg tax-free, and they can be withdrawn for qualified expenses without a tax liability.

Disclosures: There is a risk that the investments may not perform well enough to cover the cost of college as anticipated. Investors should also consider whether their state offers any favorable state tax benefits for 529 plans, and whether such benefits are contingent upon use of the in-state 529 plan. Other state benefits may include financial aid, scholarship funds and protection from creditors.

For withdrawals not used for qualified education expenses, earnings may be subject to taxation as ordinary income and a 10% federal income tax penalty.

6. Gifting your refund. You may decide that you don’t need the money. I know folks who gave away their stimulus checks to their kids or charity. What puts a smile on your face? That may be the appropriate strategy for your refund.

7. Have some fun. As we said, the average refund check so far has been $3,263. You may take one of our ideas to heart and earmark the lion’s share toward that goal. But save some for yourself.

Whether it’s a nearby weekend trip, a day trip to the spa, or that expensive restaurant you have always wanted to try, it’s OK to take care of yourself.

These suggestions are just food for thought. But be strategic. Think long-term. And take some time to consider what you might do with your refund or an windfall you may receive. A lack of planning and impulsive decisions can be costly. And remember, we are always here to assist you.

Holding up against stiff headwinds

Last year, the reopening of the economy, new vaccines, strong profit growth and low interest rates fueled gains in stocks.

But the winds have shifted in 2022.

Inflation is a growing problem, oil and gasoline prices are up sharply, investors are grappling with the fallout of Russia’s invasion of Ukraine, and the Federal Reserve has pivoted away from its easy money policy.

Yet, as the table of returns below illustrates, the major averages have been quite resilient in the face of stiff headwinds. Credit the economic expansion and rising corporate profits. It’s not completely counterbalancing the negativity, but it has cushioned the downside.

Table 1: Key Index Returns

Source: Wall Street Journal, MSCI.com, MarketWatch, Morningstar

MTD returns: Feb 28, 2022-Mar 31, 2022

YTD returns: Dec 31, 2021-Mar 31, 2022

*In US dollars

Bonds have entered a new arena. In a rising interest rate environment, bonds generally underperform. We have only had one rate increase this year but several more are coming. As you can see above, YTD the bond index has performed worse than the Dow Jones Industrial Average. While most people believe bonds are a safe investment that does not mean you can’t lose money in bonds. 

Stocks don’t move higher in a straight line. Volatility and corrections are to be expected, as we’ve discussed before.

Still, heightened uncertainty is rarely cause for celebration, even if losses have been relatively modest.

We don’t try to forecast when markets might correct. Instead, we make recommendations and individually craft portfolios based on several factors, including the idea that we will run into unexpected detours along the way.

Pullbacks are a normal part of investing. They are sparked by unexpected events. We will usually experience several corrections over the course of an economic expansion. But history says they are temporary.

While uncertainty generated by geopolitical events have rarely caused long-term damage to the major market indexes, they do create short-term volatility.

You see, the initial news of an event usually generates heightened uncertainty, which forces short-term traders to pull back. But if the crisis does not affect U.S. economic activity, investors typically incorporate the new normal into their outlook.

Let’s look at Ukraine. It’s fair to say this isn’t your typical geopolitical event. But so far, it seems to be following the historical pattern.

But let’s acknowledge the obvious. What is happening in Ukraine is far from ideal, and how the war may unfold is a big unknown. Recently, there have been no significant developments that might negatively affect investor sentiment, and investors seem to be taking the apparent stalemate in stride.

It’s not that we are immune to the horrific acts of aggression by Russia. We’re not. But investors look at geopolitical affairs through a very narrow prism. That is, how will an event or events impact the economy?

Few see a cessation of hostilities in the near term. However, investors may slowly be growing accustomed to the daily reports coming out of Ukraine. It’s as if we are becoming comfortably uncomfortable with the war.

Put another way, investors seem to slowly be incorporating a new normal into their collective outlook, as there hasn’t been a significant shock to demand for goods and services at home.

But you may ask, what about oil prices? What about the surge in gasoline prices? For starters, it’s painful every time we fill up. And it will translate into higher inflation.

But the broader economic impact is less certain. For every penny increase in the price of gasoline, U.S. consumer spending drops by $1.18 billion a year, according to an estimate from Federated Global Investment Management (Bloomberg).

For example, a $0.75 jump in gasoline, if maintained over a year, would hit spending by roughly $90 billion. But U.S. Gross Domestic Product is over $24 trillion, which would translate to less than 0.4% of GDP. It’s not insignificant, but by itself, it’s not enough to throw the economy into a recession.

Then there is the Federal Reserve. Its commentary has grown increasingly aggressive as it hopes to rein in inflation.

At the March meeting, the Federal Reserve raised the fed funds rate by one-quarter of a percent to 0.25%–0.50%. Its own Summary of Economic Projections suggests we may see a fed funds rate of 1.75%–2.00% by year end. And, as Fed Chief Powell has said, don’t discount the possibility of at least a half-percentage point rate hike (or hikes) at upcoming meetings.

Why is this important? For savers who want safe, interest-bearing investments it’s good news.

For equity investors, it’s more problematic. When bond yields and interest rates are low, they offer little competition to stocks. But rising rates and yields could encourage some investors to look at alternatives outside of equities.

From an economic perspective, some are asking if the Fed can bring inflation back down without causing a recession.

In past cycles, rate hikes were pre-emptive and proactively implemented to stave off any future jump in inflation. The Fed succeeded in engineering what’s called a soft landing in the mid-1980s and mid-1990s.

Today, the Fed is reacting to higher inflation. It creates economic uncertainties that we will carefully monitor throughout the year. Only time will tell if they are able to engineer a soft landing.

I trust you’ve found this review to be educational and helpful. If you have any questions or would like to discuss any matters, please feel free to give me or any of my team members a call.

As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor.

Kind Regards,

Niles P. Geary, II, MBA, CRPC, AIF™ 

Co-Founder & CEO 

Niles P. Geary, II is Registered Representative offering Securities and Advisory Services through UNITED PLANNERS FINANCIAL SERVICES, A Limited Partnership Member: FINRA, SIPC Voyage Partners Financial Strategies, LLC and United Planners are not affiliated. 

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