Some smart ways to handle that 'gift' from Uncle Sam

Many folks believe that their tax refund check from Uncle Sam is free money. Be honest: Are you one of them?

I am sorry to report that's not an accurate assessment. If you're getting a large refund, you've given the Internal Revenue Service an interest-free loan of your money for the previous year — and we're sure you could have come up with a better use for that money than that.

Uncle Sam
Erich Schlegel | Getty Images

If you are getting a refund this year, you are not alone. In a study conducted by Harris Poll, 69 percent of Americans expect a tax refund this year, with the average refund being $3,120.

A study by Lexington Law reported that 35 percent of Americans who expect a tax refund this year have plans to spend it on something nonessential — vacation, entertainment or an electronic or mobile device.

Men tend to look at refunds differently than women. According to a study by interest rates-focused website, women who expect a tax refund are most likely to say they plan to use it to pay down debt, at 29.9 percent. Women selected this answer about 20 percent more often than men. However, men are also more likely to regret a purchase made with their tax refund than women (21 percent vs. 16 percent).

It turns out that the old saying "Older is wiser" is true when it comes to tax refunds, as well. The older you are, the more likely you are to be smarter with your tax refund. According to the Lexington Law study, men and women between the ages of 18 and 34 (44 percent) and 35 and 44 (38 percent) are more likely to spend their tax refund on something nonessential.

Given that information, it's no surprise that someone's age is also correlated to reporting a better credit score. As your age increases, the chance of reporting an excellent credit score increases, too. When comparing those in the age groups of 18–34 and 45-plus, the older generation was 67 percent more likely to report an excellent credit score compared to 53 percent of those younger than 35.

Sadly, looking at the trends of these spend-happy people, those with poor credit scores are some of the worst offenders. Lexington Law claims that those with low credit scores are more likely to consider a tax refund as a bonus check that should be used to buy themselves something rather than to pay off a debt (39 percent vs. 22 percent).

It turns out that credit scores, which are meant to help predict the financial behavior of individuals, are pretty right on. Low scores often equal high credit card balances. The amount of debt one person carries accounts for nearly a third of a FICO credit score, making it a very important factor for debtors to understand. Borrowers need to be careful about how much debt they carry if they hope to achieve a high credit score.

Based on this data, this highly indebted segment of the population — more than any other — needs to use these funds for debt repayments rather than lavish vacations or fancy new electronic devices.

So how do people handle their tax refund?

Are you a millennial with student loans and credit card debt to pay? Are you over the age of 45 with a good credit score, but the bills are still piling up? What is the temperature in the Bahamas right now?

There are many questions to consider when you receive your tax refund this year, but all of your answers should lead you to putting your money toward paying off bills and debts first. No one wants to be in the 18 percent of Americans that have later regretted a purchase from their tax refund this year.

The bottom line is that we should all look at our tax refund as earned income, not a bonus check. When you get your tax refund this year, go through this short checklist to see if you can make smarter decisions about this "free money" and assure yourself a secure financial future instead of the new iPhone or a week on the beach.

  • All my bills are paid.
  • Credit card debt is paid off.
  • My emergency fund has at least three months' worth of living expenses.
  • Student loans are paid off.
  • Retirement savings are on track.

Once you have checked these off, then feel free to make the best use of the remaining balance. If there's enough left over, you might even buy yourself a nice gift.

— By Stacy Francis, president and CEO of Francis Financial