So, you received a tax refund. Hooray! Now, it’s time to decide what to do with it.
Maybe you’ve been dreaming of a Las Vegas vacation? We get it. Vegas is fun. However, it’s important that you use your tax refund wisely. That money from Uncle Sam can help alleviate outstanding financial commitments and improve your financial well-being. Ultimately, that’s what will get you on the right path to being able to take a Vegas vacation every year or wherever else you’d like to travel.
In this article, we’ll discuss some smart ways in which you can spend your tax refund. We’ll also show you how you can assess your own financial situation and determine the best use of your tax refund.
You’ll need to examine your personal finances to determine the best course of action. Start by answering the following:
Do you have consumer debt?
According to CreditCards.com data, credit card interest rates generally range between 15–25% and sometimes more. Paying down this debt is a good idea, as interest and fees can cost a significant amount of money over time.
Do you have emergency fund savings?
Financial experts recommend having three to six months' worth of living expenses saved. This way, if the unexpected happens, such as the loss of a job, you can support yourself. Starting or adding to your emergency fund is a smart way to use your tax refund. It puts you in a position to deal with unexpected expenses. When large expenses do come up, you can draw from your saved funds (instead of swiping the credit card and taking on debt).
For many people 3–6 months' worth of expenses may seem unrealistic, but don’t let that discourage you. Anything you’re able to save can help.
Do you have student, auto, or personal loan debt?
Getting a tax refund presents a great opportunity to pay off any non-mortgage debt. After credit card debt, student loans and personal loans typically have the highest interest rates. For instance, private student loans have interest rates ranging from 4–15% or more, according to NerdWallet research.
Auto loans are sometimes lower, depending on your credit. If you have an auto loan with a higher interest rate, such as 7%, it may be a good idea to make an extra payment using your tax refund. If you make extra payments toward the principal, you can shorten the length of the loan while decreasing the total amount of interest you'll pay over the life of the loan. Make sure there are no prepayment penalties, and that the extra payment goes towards the principal.
Have you saved money for retirement?
64% of Americans aren’t prepared for retirement, according to a GOBankingRates survey. If you haven’t given your retirement much thought, now is the best time to start! Using your tax refund to contribute to an employer-sponsored retirement plan, such as a 401(k), is advised. Many companies match your contributions up to a certain amount which means free money! If that’s not an option, put your tax refund money into an individual retirement account (IRA).
In addition to building a nest egg for later in life, retirement contributions offer significant tax advantages. Contributions to traditional IRAs, for instance, are tax-deductible. Contributions to Roth IRAs aren’t tax-deductible, since they’re made with after-tax money. However, withdrawals from a Roth IRA after you retire are tax-free (traditional IRAs are not). Essentially, with IRAs, you can choose whether to enjoy tax deductions now or later.
Have you saved for your children’s higher education (or your education)?
College may be one of the largest expenses you ever incur. For the 2019–2020 academic year, a U.S. News report found that the average college tuition fees range from $10,116 per year (public, in-state) to $36,801 (private). And, that doesn’t even account for books, dormitory fees, food, and other living expenses. Here’s the good news: You can contribute to a 529 college savings plan or education savings account. Many states provide tax benefits for 529 account contributions. Check with your state to see what they offer.
Do you have any major savings goals, like a down-payment for a house?
Are you planning to travel abroad, buy a car, do a home improvement project, or buy a house? Then putting money toward those purchases is a smart way to spend your tax refund.
Let’s say the average cost of a home in your area is $150,000. If you want to buy a home, you’ll need 20%, or $30,000, for the down-payment to avoid private mortgage insurance (an additional fee that costs thousands of dollars over the life of a loan). If you get $2,000 back from Uncle Sam, it may make sense to put the money toward saving for a down-payment.
Do you have term life insurance?
If you haven’t built up wealth, consider term life insurance as a security blanket for your spouse, children, and other loved ones. Term life insurance provides coverage for a set period of time, such as 20 years. If you or your spouse dies during that time, the death benefit will be paid in full to your beneficiaries.
According to Investopedia, term life insurance doesn’t cost that much. A healthy 35-year old could get a $250,000 policy for as little as $20 to $30 per month for 20 years. Yes, it’s an expense you don’t get back. But term life insurance ensures that your loved ones are taken care of in the event of a tragedy.
What if I’ve been on top of everything financially?
First of all, kudos to you! If you’re in a good financial position already, then some smart ways to spend your tax refund are:
Paying down your mortgage
Investing in assets like stocks, real estate, gold, etc.
Donating to those in need (and you may be able to claim a charitable donation tax deduction)
Helping others is truly one of the best things to do with your tax refund. You’ll feel great knowing your donation has helped improve life for people who have been less fortunate.
Let’s say you got $2,000 back from Uncle Sam. You’re being smart and taking the time to decide what to do with your tax refund. After assessing your financial situation, you find:
You have $2,000 in credit card debt you want to get rid of.
You haven’t been saving enough for retirement or your child’s education.
You’d like to start an emergency fund.
Now, what should you do with your tax refund? It’s really up to you. If you don't want to deal with credit card bills and want to get rid of debt, you could use that $2,000 to clear your credit card balances.
Or, you could tackle each of your financial needs bit-by-bit:
Use $500 to pay down your credit card debt.
Put $300 into your company’s 401(k).
Put $200 into your child’s 529 plan.
Put $1,000 into your emergency savings account which will protect you from having to take on more debt later.
Your individual wants and needs may differ—you may, for instance, want to get rid of your debt entirely before taking care of other expenses. However, this is a good example of how to tackle multiple financial concerns by using your tax refund wisely.
We’ve discussed several smart ways to spend your tax refund. As you figure out what to do with your tax refund, remember there is no one-size-fits-all approach.
To decide what’s best for you, analyze your unique financial situation. If needed, consult with a financial advisor for individualized advice. They’ll help you crunch the numbers and see what financial moves put you in the best position to succeed.
It’s also important to educate yourself. Resources like this article can help you choose what to do with your tax refund. Here at Personify Financial, we have a wide variety of other financial education resources that can help set you up for success.
Through education and careful analysis of your financial situation, you’ll know the best way to allocate your tax refund. Then, all you’ll need to do is take action.