Despite planners' advice, many spend tax refunds

So, in February, the couple closed on a house in Braintree and claimed the credit on their 2008 tax return, resulting in an $8,000 federal income tax refund. But instead of rushing out to spend it on a lavish vacation or expensive new furniture, they put the bulk of the money in the bank.

"Now we have a nest egg," Dirocco, 29, said. "It's such a good feeling."

In this recession, there's a glimmer of hope: More people are getting tax-refund checks this year, in part because of the new home buyer credit and other incentives. The Internal Revenue Service said personal income tax refunds rose 11 percent this year, to $207.8 billion. But while the temptation may be to spend the windfall on a vacation, new car, or even on everyday expenses, financial planners say the best thing to do is save the money in this uncertain economy.

"That's not to say taking it to go to a Red Sox game or a night out on the town wouldn't be fun, but in this environment we want people to consider what can go wrong," said Larry Glazer, a financial planner and managing partner of Boston-based Mayflower Advisors LLC.

"You can still treat yourself," he said, "but it's going to have to be in much smaller ways than in the past."

But despite the weak job market, falling wages, and other economic concerns, many Americans are planning to do the opposite: They plan to spend their tax refunds.

According to an Associated Press-GfK poll of 1,002 adults conducted this month, 54 percent of the respondents said they plan to use their refunds to pay down credit card debt, up from 35 percent from a year ago.

Just 5 percent were planning a shopping spree, about the same as last year.

And those making less than $50,000 were more likely to use their refunds for everyday items and for household expenses.

Only 35 percent said they plan to save or invest a tax refund, according to the survey.

Financial planners say people should try to save as much of their refund as possible. While the oft-repeated advice of having six months' worth of living expenses in emergency savings may seem unrealistic for many people - particularly in this economy - some planners say a tax refund can offer a partial cushion if income suddenly drops. They suggest putting your emergency stash into a money market or savings account.

"Right now, cash is king, so it makes sense to keep as much as possible available," said Bruce Fenton, founder and President of Atlantic Financial Inc., in Norwell. "Economic troubles may continue for months or even for many years, and it's best to plan for the worst and hope for the best."

Paying down debt is another option, said Glazer, the Boston planner. While he advises most clients to save, he said other smart moves include maxing out an individual retirement account, or IRA, contribution for the year or setting aside money in a college savings plan. He also suggests that some clients make an extra mortgage payment, if possible.

"Over the past 20 years, this mindset has evolved that mortgages are 'good debt,' and that's part of the reason we're in the mess we're in - people took out loans they couldn't afford or you had people nearing retirement getting into 30-year mortgages," Glazer said. "When you look at the true cost of a loan over time, whether it's a mortgage or a car loan, it's enormous, and it starts to make sense to make an extra payment if you can."

In an ideal world, people would make the appropriate deductions, accurately predict their income, and neither owe nor be owed money come April 15. In most cases, a tax refund amounts to the repayment of an interest-free loan to the federal government. But Ed Smith, a tax partner in the Boston office of BDO Seidman LLP, knows many people who use the refunds as forced savings programs.

"Typically, though, it seems like it would be better to plan the exemptions so you won't owe a lot of money or have a big refund," he said.