If you’re among the lucky Americans who will get a tax refund this year, it’s essential to plan what you’ll do with it.
While a shopping spree or dream vacation sounds fantastic, it’s not the most responsible thing to do with your money since it’s not a refund but money you earned and lent to the government.
Consider These 12 Smart Ways to Spend Your Tax Refund
Pay Off Your Debt
High-interest credit card debt is the worst budget killer. It can keep you from saving for retirement, college, or even an emergency fund. In addition, the compounding interest increases your debt monthly.
Even if your tax refund doesn’t pay the debt, take a bite out of debt. Even a few thousand dollar payments can save you hundreds in interest and months of expenses.
No investment will match the interest you pay on your credit cards (unless it’s a 0% APR). So paying your credit card debt off as early as possible is the best investment you can make.
Set Up an Emergency Fund
Life happens when we least expect it, and sometimes it’s unpleasant. However, without can be ten times worse without an emergency fund because of financial stress. Not having the money to fund a major repair, take care of large hospital bills, or cover damages caused by accident could be devastating.
Going into credit card debt or any other debt only worsens the situation. If you don’t have an emergency fund or have at least six months of expenses set aside, use at least some of your tax refund for the emergency fund.
Put your emergency funds in an online high-yield savings account to earn higher interest rates, which are not easily accessed. Opening an emergency fund at your local bank with a nearby ATM is not the best idea.
Suppose you haven’t started an emergency fund yet, set aside $1,000. This will get you through basic emergencies without using credit cards, but don’t stop there. Keep your efforts going even after funding your account with some or all of your tax refund.
Invest in Your 401K
For example, if your employer matches 3% of your salary dollar-for-dollar and you make $75,000, that’s $2,250 in free money. But you must contribute $2,250 for the employer to match it.
Use your tax refund money to offset the deductions from your paycheck and enjoy the ‘free’ $2,250 contribution to your retirement account. It may not sound like much, but with compounding, that $2,250 will be worth a lot more in retirement and get you closer to your retirement goals.
Invest in an IRA
If you don’t have an employer-sponsored 401K or you maxed it out, consider opening an IRA. You can contribute up to $6,000 per year in a traditional or Roth IRA.
A traditional IRA gives you a tax deduction this year (or the year you contribute), and a Roth IRA gives a tax break during retirement. You pay the taxes at your current tax rate, but your contributions and earnings grow tax-free.
Any money you invest in an IRA must sit until you are 59 ½ years old. If you withdraw the funds early, you’ll pay a 10% penalty for most cases, plus any applicable taxes.
Invest in a Taxable Account
If you’ve maxed out your 401K and IRA contributions, consider investing in a taxable account. You don’t need much money to invest – you may even get by with $100 or less to open an account.
Try a robo-advisor like Wealthfront, Betterment, or Robinhood. They have low minimum balance requirements and affordable fees. You don’t even have to know much about investing in getting started. After you answer basic questions about your goals and risk tolerance, they create and manage a portfolio for you.
A taxable account doesn’t offer tax breaks like a retirement account, so you can use the funds as needed, withdrawing from your account at any time. However, watch out for the tax liability they incur if you have capital gains.
Pay Down Your Student Loans
Student loan debt can follow you for many years, costing you thousands of interest. If you’re on the traditional payment plan, consider paying your balance. You’ll save thousands of dollars in interest and pay your loans off faster.
Student loans can get in the way of getting approved for a mortgage or even saving for a down payment on a house. While it may not be what you want to do with the funds, it will put more money in your pocket.
Save for a Down Payment on a House
If you aren’t a homeowner, consider using your tax refund as the down payment or at least a start. Today, you don’t need a 20% down payment on a home – you can get by with much less down with an FHA loan.
If you already have a down payment saved, the tax refund can help cover the closing costs, which can cost 2% – 5% of the loan amount. For example, if you borrow $200,000, that’s $4,000 – $10,000 in closing costs on top of the down payment.
Pay Extra Mortgage Principal
If you are a homeowner, consider paying your mortgage balance down with your tax refund. Like student loans, if you pay the principal balance down faster, the loan accumulates less interest. Depending on how much principal you pay down, you may even cut years off your mortgage.
Since most mortgage loans are for 15 – 30 years, you could own your home free and clear much faster than a lifetime. You can spread your payments out monthly, paying an extra $100+ per month, make a lump sum payment, or spread your additional principal payments out equally over a few years.
Open a 529 Savings Plan
If your kids are college-bound, or you think they may be, invest in a 529 Savings Plan. Each state has different options with different tax benefits. Always check your state first because you’ll get the most tax benefits there, but explore other state options to compare your options.
The 529 Savings Plan funds grow tax-free, and if you use the funds for eligible educational expenses, you pay no taxes. If your child doesn’t attend a university or 4-year college, you can use the funds for any ‘eligible’ education expenses, including trade school, community college, and even K – 12 expenses.
Invest in Yourself
Don’t leave yourself out of the equation when you think of investing. You can invest in yourself in many ways:
- Go back to school
- Get certification for your job or industry
- Get a degree to get a promotion at your current job
Invest in Your Home
If you own a home, investing your tax refund will give you the greatest return. Make improvements that increase a home’s value, such as minor kitchen and bathroom remodels, upgrading your home’s curb appeal, or adding a deck or patio.
Before you invest, talk to a real estate agent or licensed appraiser to see how much the intended repairs or renovations will improve your home’s value.
Start a Business
Use your tax refund if you’ve always dreamed of starting your own business. You don’t have to leave your job to start a business – start something on the side and see how it goes. If it grows enough that you can make it your full-time employment, go for it. Otherwise, use the money from your side hustle to reach your goals.
Think about where your tax refund would do the best in your life. Both are great places to start if you haven’t saved a penny in your emergency fund or for retirement. On the other hand, if you’re all set in those areas, branch out and look at other sites, and you can invest your money.
Even if you split the refund up among a couple of investments or areas of your life, putting the money to good use is crucial. You’ll get the most bang for your buck and give yourself a head start on creating your desired future.
High-interest loans can be expensive and should be used only for short-term financial needs, not long-term solutions. Customers with credit difficulties should seek credit counseling. The opinions expressed above are solely the author’s views and may or may not reflect the opinions and beliefs of the website or its affiliates. Cash Factory USA does not provide financial advice.
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