Congrats on your tax refund!
In essence, a tax refund is just a refund of your own money. It’s money you likely worked for and earned, which you sent to the government as an overpayment of what you owe.
Given that new perspective, do you know what to do with your tax refund? It may be tempting to go out and spend it on something you’ve always wanted, it’s worth looking at the big picture. Keep your eye on the prize: your financial future.
Here are some better things you should consider using your tax refund on.
Pay Down Debt
If you have an excessive credit card or student debt, you’ll save a lot of money in interest payments if you use your tax refund towards paying it down. The interest rates on your debt very likely exceed any interest or investment return you could earn if you saved or invested the money. If you’re in debt, you shouldn’t be spending on more things that you couldn’t afford with your own income.
Choose your strategy and pay the debt down accordingly:
Debt snowball method – If you thrive on quick wins, line up your debts in order of balance, smallest to largest. Take your tax refund and apply it to the smallest debt. If there’s money left over, you should put the remainder toward the next one in line.
Debt avalanche method – From a purely financial perspective, the smarter approach is to line up your debts in order of interest rate, largest to smallest. Take your tax refund and apply it to the first debt in line. If you have money left after paying off the debt with the highest interest rate, pay the remaining amount toward the next debt.
Build up an Emergency Fund
Your emergency fund should have 3 – 6 months of income in it. If you aren’t even close to that or don’t even have your first $1,000 saved, your tax refund can help your progress towards that goal. At the very least, you’ll have a small pot to rely on should something unexpected occur.
The idea is to keep building on this momentum, though. Even if you only save a few dollars a week or only set aside a small percentage of your income each month, every dollar counts. Letting your tax refund start the process can be wildly motivating.
Save for Retirement
How are your retirement savings? Have you given them a second thought? If you haven’t been saving for retirement at all, your tax refund is a great way to start. If you have been saving but haven’t maxed out your contributions ($19,500 in a 401K and $6,000 in an IRA), use your tax refund to max out those contributions and possibly gain some tax benefits as a result.
Save for College Education
Don’t rely on financial aid for your child’s college education. While you may get some, you never know. Education grants are need-based, college scholarships can be unpredictable, and student loans can put a damper on your finances (or your child’s).
Setting up a 529 plan provides a tax-advantaged way to save for your child’s education. Better yet? Even family members and friends can contribute to the account through the years if they wish. Whether you have an account set up already or you haven’t even started, let your tax refund add a nice chunk to the account and get your child started on the right foot.
Pay for Education or Professional Development
Don’t discount the value of investing in you. Is there something you’ve always wanted to do? Is there a certification your job requires, but you haven’t had the funds to make it happen? Now is the time to use your tax refund to invest in yourself and develop yourself professionally.
Whether you take a course, start your own business, or go back to school as an adult, anytime that you invest in yourself, there’s always a high return on the investment.
Invest in Your Home
When’s the last time you fixed up your home? Are there projects you dream of but think they’d never be feasible financially? Your refund check can be a great source of the funds. Whether the funds are just the start of what you need to save or you can make a bunch of small improvements with the funds, the return on your investment will be apparent when your home value increases.
Start a Savings Account for a Goal
Do you have a lofty goal that you think you’ll never meet? Use some or all of your tax refund to save toward that goal. Name the account if you want, and as you can add to it so that you can get closer to reaching your goal.
Knowing how to use your tax refund wisely is essential. Just going out and spending your money on frivolous ‘stuff’ won’t get you anywhere; sure, you’ll have new possessions, but at what expense? What does your future financial self have to show for it?
Look at the big picture. Where can you invest your tax refund so that it gives you the most bang for your buck? Where can you invest it so that your future financial self is more secure? Look at your immediate situation, including your debts and emergency fund. If there’s too much debt or a lack of an emergency fund, start there. If you’re set in that respect, then look at the bigger picture – consider how you can invest now to make financial security attainable either in retirement, for future expenses, or even to reach future goals.