Conquer your student debt. Refinance now.
Each spring, Americans are all required to file our state and federal taxes with the IRS, which can be a tedious task. However, deciding how to spend your tax refund check from Uncle Sam can be much more enjoyable.
The average refund was about $3,100 in 2020; that’s not a small windfall! Keep in mind that your return isn’t ‘free money’. This is money that came out of your paycheck each month and you now get back. If you didn’t already have your tax refund earmarked for something, here are a few smart things to consider.
Pay Down High-Interest Debt
If you have the rain cloud of high-interest debt hanging over your head, your tax return could make a dent in that debt. With interest compounding on you every month, getting rid of this burden could mean freeing up your future cash flows.
Credit card debt, in particular, can be a large burden, with a high-interest rate, and can have a negative impact on your credit score. The national average APR is around 17%, but some cards may charge even more on any balance you carry month to month.
This method of focusing your extra funds towards paying down one large, high-interest debt is called the snowball method. Popularized by Dave Ramsey, this debt repayment method focuses on paying down expensive, high-interest debt as soon as possible, and then refocusing on the next highest interest debt. This could be a payday loan, car loan, student loan, mortgage, or whatever else is the most pressing issue to improve your financial situation.
If your refund doesn’t cover the entire outstanding balance on your high-interest debt, making a dent in the principal amount could still put you in a better position to cover the rest within the next year.
Create an Emergency Fund
If you don’t already have an emergency fund, your tax refund could be a solid foundation to start putting aside extra money tax season. An emergency fund is your rainy day bank account, a cash reserve that you can draw from if an unexpected expense comes up.
To be clear, a surprise weekend getaway, day to day living expenses, or a new tv is not an emergency. Your emergency fund should be reserved for events like a broken car, a surprise medical expense, a ticket, job loss, etc. Things that you didn’t plan to save money for and can’t avoid paying.
How much you set aside for an emergency fund is different for each person. It is generally recommended that you have two to three months’ worth of your normal expenses in your emergency fund, but you might consider more. Think about the last couple of surprise expenses that have come up and use that as a guide to get started. While your refund might not match that number, it can be a strong start.
Once you get started, you can even direct deposit a portion of your income into this slush fund for a rainy day, to build it up slowly over time.
Open a Targeted Savings Account
If you have ever been tempted to use your existing emergency fund on a new piece or technology, a vacation, or any other treat-yourself event, a targeted savings account might be a good place for your tax refund.
A targeted savings account doesn’t have to be separated from your current savings, it is just the funds that you have earmarked for some big-ticket event or item. The idea is similar to the emergency fund, but is more about jump-starting specific savings goals instead of emergency preparedness.
Invest Your Tax Refund in the Stock Market or Retirement Savings
One of the best things you can do with your money is to make it work for you. Investing your tax refund is one way to try and grow that money over time. Some people feel apprehensive to begin investing because they don’t have the funds to begin, but a tax return can allow them to start the process and accumulate interest over time.
If you already have a 401(k), Roth IRA, or Traditional IRA retirement account, you could consider adding your tax refund to your existing investment account. However, it is important to remember that for 2020, if you are under 50, the maximum contribution amount to a retirement account is $19,500. You might want to do some math to decide if this is the right move for your personal finances.
It is important to note that all investing comes with risks. You could end up losing your tax refund if your investments fail to perform. Talk to a financial advisor if you want advice on making a plan specific to your risk profile, or consider a robo-investor if you prefer a low-cost, passive option.
Read more: 6 Reasons Why You Should Start Investing Now
Invest In Your Real Estate
While a tax refund alone might not be enough for a down payment to buy that dream home, it could help you make improvements to your current home. Home improvements can increase the overall value of a home, which will make it more valuable when you do decide to sell.
Not all investments are about the future price of a home, but about making it a better fit for your family. Or fixing something that has been broken and was just over-budget. Maximizing your enjoyment in the home is a worthy investment for your tax refund.
Invest in Yourself
Have you been wanting to learn a new skill, or become better at something you already do? Spending your tax refund on a class or program to improve yourself is another way to invest in your future.
This could be something you have always been interested in as a hobby, or something that could help you level up at work. While one might pay for itself over time, learning a new skill that you enjoy is an investment in your happiness.
Or maybe you have been eyeing a piece of equipment or technology related to your hobby or work. This one-time spend could pay dividends in the long-term as something you continue to use.
Donate a Portion of Your Tax Refund
If you have a charity that you support, a tax refund that you haven’t budgeted for could be a nice one-time donation. Spending on your debt is important, but if you are lucky enough to be debt-free at this time, consider making a donation you might not have been able to swing before.
Don’t Forget to Have (a Little) Fun
If you have been good about your budget and don’t have an immediate need for your tax refund, you might consider giving yourself a pat on the back for hitting your financial goals.
This splurge could come in the form of the bag you didn’t buy because you needed to make a loan payment. The gaming system that was had to wait because of a surprise car repair. Or the trip home to see your family that was too expensive over the holidays. Just make sure you keep your purchases in control and you don’t go on a shopping spree.
It is important to practice fiscal responsibility, and equally important to reward yourself for meeting your goals.