Don’t blow your tax refund, make your money work for you

That happy SMS from Sars confirming your tax refund has landed can feel like winning a small lottery.

But before you book that holiday, splash out on shopping or start planning how to spend every cent, financial adviser Marnus Mostert says taxpayers should pause and give their refund a job.

Mostert, franchise principal and financial adviser at Consult by Momentum, warns that a tax refund is not a bonus.

The refund could come from medical aid credits, retirement annuity contributions, or other tax deductions that were not fully accounted for during the year.

Instead of treating the lump sum as free cash, taxpayers should consider whether it could help reduce debt, boost retirement savings, or build an emergency fund.

Mostert suggests asking four questions before spending it: What is the most expensive money on my balance sheet? What happens if something goes wrong next month? Am I leaving valuable tax breaks on the table? And what do I want this money to do?

For consumers struggling with high-interest debt, a refund could provide breathing room.

Putting extra money towards debt can reduce interest costs and free up income over time. Mostert recommends tackling high-interest accounts strategically, while some consumers may prefer paying off the smallest balance first and then using the money freed up to tackle the next debt.

For example, someone with R2.75m in debt – made up of a R2m bond at 10%, a R650,000 vehicle finance at 11%, and a R100,000 personal loan at 18% – could have minimum repayments of about R35,972 a month.

“If that person adds R3,833 a month, equal to a R46,000 annual tax refund, towards the debt, they could potentially save R1.5m in interest and become debt-free about a decade sooner, using the debt snowball approach made famous by Dave Ramsey,” says Mostert.

A retirement annuity can give the money years to grow and benefit from compound interest. A tax-free savings account is another way to build wealth over time.

Mostert points to the power of reinvesting the refund generated by retirement annuity contributions.

If someone contributes R46,000 a year to a retirement annuity from age 33 to 65, assuming a 9% annual return after charges and a 45% marginal tax rate, they could retire with about R7.91m if they spend the refund each year.

Reinvesting the refund into the same retirement annuity could increase that figure to about R13.63m.

“A tax-free savings account works differently. Contributions do not provide an upfront tax deduction, but interest, dividends, and capital gains are not taxed,” says Mostert.

A 33-year-old investing the R46,000 annual limit until reaching the R500,000 lifetime cap could have about R4.38m by age 65, compared with about R3.31m if the same contributions were made to an ordinary taxable investment.

Having savings available means consumers can deal with these shocks without reaching for expensive credit.

Mostert says consumers do not necessarily have to choose just one option.

The money can work like a waterfall – starting with retirement savings, using the resulting refund to build a tax-free savings account, and, once its limits are reached, directing additional money into a discretionary investment or towards debt.

The best choice will depend on each person’s circumstances, including debt levels, emergency savings, age, marginal tax rate, and how long the money can remain invested.

The smartest move, Mostert says, may be deciding what to do with the refund before it arrives.

“Make the decision when you file your return and give the money a job before it even lands.”

The refund may not be a windfall – but it can create a waterfall.