If you've been counting the months until you receive your annual bonus or tax refund, you're not alone.
Two out of three Americans said they've been blowing through their savings to cope with inflation, a 2022 Forbes Advisor study found. Others are relying on credit cards. In the third quarter of 2022 alone, credit card balances increased by $38 billion. That's 15% more than a year earlier, representing the largest year-over-year increase in more than 20 years, according to the Federal Reserve Bank of New York's Center for Microeconomic Data.
All that spending just to keep up with rising prices may influence what some consumers choose to do with their tax refunds and annual bonuses, particularly in lower-income households that may be struggling to make ends meet, experts said.
That new car may have to wait
"Among families struggling to keep up with the pace of inflation, I think we may see tax returns that might have otherwise gone toward a big annual purchase, whether it be a car or a computer, instead be used to cover ongoing and regular expenses or to pay down debt they have been forced to acquire to compensate for higher prices," said David Reynolds, director of product strategy and credit delivery with BOK Financial®.
Other consumers may be concerned about the potential for more financial hardships this year and use their tax refunds and bonuses to beef up their emergency funds, said Amanda Barrett
senior consumer product manager with BOK Financial.
"We're entering period with a lot of unknowns," she explained. "With the Fed raising rates, the end goal is really to slow consumer demand. They're trying to slow down the economy , which means a certain amount of job loss should be expected. How much slower, how much job loss, is really anyone's guess. That puts people in a position where they may be focused on adding more to their emergency fund."
How to decide
The best use of your tax refund or annual bonus really depends on your unique financial situation, but consider these factors, experts said.
For instance, since interest rates are higher than they were a year ago, it's costlier to carry credit card debt. Paying down balances can save you on interest and might even improve your credit score, Reynolds noted.
But if you don't have an emergency fund—ideally totaling a few months' worth of expenses—you may want to build that up instead. "Independent of the interest rates, having that emergency fund available should something go wrong is invaluable, so the first thing to address is really that base level of security," he added.
When deciding how much emergency savings you need, it's important to take inflation into account, Barrett said. "The dollar doesn't go as far as it used to. In the past, where somebody may have felt pretty good with a $2,000 cushion, they may not feel as good about it right now, so I expect some people to try to increase their savings."
Another factor to consider is your age, including how close you are to retirement, Barrett said. For example, older individuals may choose to max out on their retirement savings, including "catch-up" contributions, which may also help reduce your tax burden. They may also choose to "ladder" certificates of deposit (CDs)—that is, put money in CDs with different maturity dates—or invest in stocks.
Anecdotally, she's seen generational differences between how people choose to use their tax refunds or bonuses. For example, young consumers tend to spend the money on goods—such as a down payment for a car or paying for a couch—or opt to pay down student loans or build savings. Meanwhile, Barrett has seen people in their late 20s through early 40s choose to continue to build their emergency funds, contribute to their retirement savings, pay down credit card balances, or contribute to college savings plans for their children.
Your financial advisor can help you decide what's right for you, so tax return and bonus season is a great time to meet with them, Barrett noted.
"They really should be your guide, and to create a trusting, truthful relationship, there has to be communication there," she explained. "If your advisor says you need to meet every three months, then you probably need to meet every three months, but typically once a year is the recommended standard."
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