As tax season approaches, many military families find themselves anticipating the arrival of their tax refunds. For some, this extra sum of cash can be a great boost to their financial wellness. However, it’s important to have a plan in mind to make the most of it. Let’s explore what it means to receive a tax refund (it isn’t always a good thing!), how military income factors into taxes, and smart strategies for saving and investing your tax refund effectively.
Understanding Your Tax Refund
First, let’s clarify what a tax refund is. When you file your annual tax return, you’re reconciling the taxes you’ve paid throughout the year with what you owe. If you’ve had more taxes withheld from your paychecks than necessary, you’ll receive a refund from the government. Think of it as getting back the extra money you’ve essentially lent to the government throughout the year, interest-free.
Some people prefer NOT to get a tax refund, so they can get more money from their paychecks throughout the year and invest it as they go. If you’re consistently getting large tax refunds, you may want to adjust the withholdings on your paychecks.
Military Income and Unique Tax Situations
Military families sometimes see huge differences in their tax refunds, even when they haven’t changed the service member’s withholdings. Why does that happen?
One unique aspect of military life is that some income earned by service members is tax-free. For example, allowances like BAH (Basic Allowance for Housing) and BAS (Basic Allowance for Sustenance) are exempt from both federal and state taxes. Additionally, combat pay in specific deployment locations is exempt from federal income tax. While this can reduce your family’s overall tax liability, it’s important to understand that other sources of income, such as base pay and bonuses, are still taxable. If you receive COLA (Cost of Living Allowance) in the Continental US (CONUS), that allowance is taxable.
Military families should carefully prepare their taxes each year. Factors such as deployments, changes in duty station, and additional income streams—like spouse employment or renting out a house you own—can all impact your tax liability. Consulting with a tax professional who understands the intricacies of military taxes can help you maximize your deductions and credits, potentially leading to a larger tax refund.
6 Smart Ways to Invest Your Tax Refund
Once you’ve received your tax refund, the next step is to decide how to use it wisely. Here are some smart strategies for military families to consider:
1. Pay Down Debt:
If you have high-interest debt, such as credit card balances or personal loans, consider using your tax refund to pay them down. Eliminating debt can free up more of your monthly income and save you money on interest payments in the long run.
Use our Get Out of Debt Checklist to get started.
2. Build an Emergency Fund:
Life in the military can be unpredictable, with frequent moves and deployments. Having a robust emergency fund can provide peace of mind and financial stability during challenging times. Aim to set aside three to six months’ worth of living expenses in a high-yield savings account or money market fund.
Learn more about Building an Emergency Fund here.
3. Contribute to Retirement Accounts:
Take advantage of tax-advantaged retirement accounts such as the Thrift Savings Plan (TSP) or Individual Retirement Accounts (IRAs). Consider allocating a portion of your tax refund to boost your retirement savings, especially if you haven’t maxed out your contributions for the year.
Take our free course on Planning for Retirement here.
4. Invest in Education:
If you have children or are pursuing further education yourself, consider using your tax refund to fund a 529 college savings plan or cover tuition expenses. Investing in education is an investment in the future and can provide valuable opportunities for your family.
Learn How to Start a 529 Plan here.
5. Diversify Your Investments:
If you’re comfortable with risk and have a longer time horizon, consider investing a portion of your tax refund in the stock market through low-cost index funds or exchange-traded funds (ETFs). Diversifying your investments can help spread risk and potentially earn higher returns over time.
Use this free calculator to decide whether it’s better for you to pay down debts or invest your tax return.
6. Seek Professional Advice:
Investing can be complex, especially for those new to the world of finance. Consider seeking guidance from a certified financial planner or investment advisor who can help you develop a personalized investment strategy based on your goals, risk tolerance, and time horizon.
Get connected to military-friendly financial advisors through The Edge.
Receiving a tax refund can be a great opportunity for military families to improve their financial stability. By understanding the effect of military income on taxes and using smart strategies for saving and investing, you can make the most of your tax refund and work towards a more secure financial future for you and your loved ones.
