It’s a new year, and with a new year comes an exciting time for many.
It’s Tax Season, and while you may not like doing your taxes, you’ll certainly like the refund that comes with them.
Although the average refund was reduced with the tax changes that took effect last filing year, those who typically received a refund will likely find themselves with an extra few thousand come tax time.
Tax season is not only exciting for many individuals, it’s a very stimulating time for the economy.
While many look at a tax refund as “free money,” the truth is that a refund is your own money being paid back to you. In other words, a refund is money you already earned that was taken out of your paycheck throughout the year by Uncle Sam.
With that in mind, a tax refund should be treated like any other paycheck and be used wisely to improve your finances. While it may be tempting to spend your refund on fun things, think about a refund as an opportunity to impact your financial goals.
What you should do with your tax refund depends on your specific situation and goals, but with improving your finances in mind, we’ve come up with a list of some of the best things you can do.
Here are 8 smart things to do with your tax refund this year.
Smart Things To Do With Your Tax Refund
Pay Down Debt
If you have any debt, the first smart thing you should think about doing with your tax refund is to pay it down.
Paying down debt helps to increase your cash flow, reduce your liabilities, and puts you in a better position to withstand any hardships. Having little to no debt also gives you more buying power to spend money on the things you really need/want.
In sum, working toward being debt-free is always going to be a good financial goal.
Your tax refund is a unique opportunity to make a big dent in any debt you have. Although it is your hard-earned money, coming in the form of a refund makes it seem like extra money, which means it’s not included in your monthly budget.
If you have several kinds of debt, look to put your refund toward the highest-interest debt first. You’ll save the most in interest by paying off high-interest debt (such as credit cards) as soon as possible.
If you don’t have high-interest debt, or you have some refund left over, consider putting some of it toward any other debt you might have. An extra payment on a mortgage or other loan will not only save you money on interest, it’ll speed up your payoff schedule.
No matter the type of debt, if you have any liabilities hanging over your head one of the smartest things you can do with your tax refund is to pay it down or off.
Build an Emergency Fund
If you’re lucky enough to be debt free, or have low-interest debt, the next smart thing to consider doing with your tax refund is starting an emergency fund.
An emergency fund is money saved to cover emergency and unexpected expenses in order to avoid using credit in these situations.
Almost half of Americans couldn’t cover a $400 unexpected expense without using credit, so chances are good that your emergency fund could use a little padding and a tax refund is a great way to get started.
Ideally, an emergency fund would cover between 3 and 6 months’ worth of expenses, but even getting started with your tax refund is better than having nothing.
Remember, an emergency fund is for emergencies/unexpected expenses only. Emergencies include things like an appliance breaking, your car needing repairs, or the loss of a job.
While it may be tempting to use money from an emergency fund for non-emergencies (we have an idea for those later), you don’t want to be stuck when a real emergency strikes.
Save for Retirement
If you feel good with your debt situation and have a good emergency fund built up, the next smart thing to do with your tax refund is to save for retirement.
Most people are saving too little for retirement or have nothing saved at all. Even though saving for retirement can be confusing and scary, it’s important to start as soon as you can and to contribute as much as you can to ensure some security in your golden years.
The easiest way to start saving for retirement is to participate in your employer’s retirement account options, many of which will match up to a certain percentage of contributions. Talk to your HR department to see what options are offered where you work.
Even if your work options are limited, you can begin saving for retirement on your own with an Individual Retirement Account, or IRA. There are tons of available resources to help you understand IRA options and places where you can open one. Your local bank/credit union should also offer information and advice and may be a good resource.
Start a Sinking Fund
You’ve paid off debt, have an emergency fund, and are saving for retirement. Now what?
If your finances are in order, yet another smart thing to do with your tax refund is to start a sinking fund.
A sinking fund is a bit like an emergency fund, but in this case the account you’re funding is to help you prepare for a known or desired expense. For example, sinking funds can be used for travel, holiday gifts, property taxes or insurance, replacing your aging water heater, or a new car.
As with an emergency fund, the goal of a sinking fund is to avoid or minimize the need to use credit to make purchases, except in this case the purchases are planned or known in advance.
Once your finances are in order you can begin to really branch out with your tax refund. Thus, the next smart thing you can do with your refund is to invest.
This is a broad topic, but for us investing means any money spent that provides a good return.
Thus, investing might mean in the stock market by opening or contributing more to a brokerage account (non-retirement). You could also invest in yourself by taking classes or doing other things to develop more skills and make yourself more valuable. Investing could also mean in alternative investments such as real estate, REITs, or others.
No matter what type of investment you choose, you’ll be putting your tax refund to good use to make yourself more money.
Save for a Down Payment
We’ve covered the smartest things to do with your tax refund for the average person, but if you already have those things covered there are a few other things you could put your tax refund toward.
Are you looking to buy a house? If so, putting your tax refund toward a down payment is another smart choice.
While some mortgage loan programs allow you to put as little as down as 3%, the more you’re able to put down the less your payment will be and the more breathing room you’ll have.
A house is likely the largest purchase you’ll ever make, and it’s important not to overstretch yourself. The more money you have to put down and in savings, and the less credit you have to use, the better off you’ll be.
Contribute to the College Fund
Aside from buying a house or working toward other financial goals, if you have kids another smart thing to do with your tax refund is to contribute to a college fund.
There are many ways you could save for college, but the most advantageous way to save specifically for college is with a 529 college savings plan. These plans allow you to save for college while the earnings grow tax-free, as well as to deduct a portion of your contributions every year.
You can even open a 529 college savings plan for yourself!
If you’re a U.S. citizen and interested in saving for college, we recommend the Oregon College Savings Plan. Even if you ultimately don’t invest with them, their website is full of valuable information about 529 plans.
Last but certainly not least, if you’re looking for something else to do with your tax refund one option not often considered is donating.
Many people receive tax benefits as a result of donating, but you can also choose to donate your tax refund and really make a difference for organizations or causes that you care about.
If you’re not sure what to do with your refund, consider making a donation.
Moral of the Story
Tax season is a stressful time for many and an exciting time for others. Whether you like doing taxes or not, most Americans will receive a nice refund this year, and it’s important to use your refund as an opportunity to better your financial life.
The first things you should consider doing with your tax refund are paying down debt, building an emergency fund, saving for retirement, or starting a sinking fund.
If you have those down, consider investing, saving for a down payment, contributing to a college fund, or donating to a good cause.
A tax refund is your hard-earned money returned to you. Make sure you spend it wisely.