Tax day is now past, and many U.S. taxpayers are eagerly waiting for their refunds to come, if they haven’t already gotten them by now. With that, countless people are wondering about the best thing to do with tax refund money.
While it may seem like your tax refund is free money, it actually represents money you earned that the government took out of your paychecks and then gave back to you because you didn’t owe that much in taxes.
The average household tax refund is about $3,000, which is a significant amount of money for most people. It’s also not difficult to spend that amount of money rather quickly on things that won’t end up benefitting your life much, and may even be the start of bad spending habits that will drag you down for the rest of the year.
Here are some of the best ways to use your tax refund to better your life, either now or in the future.
1. Pay off debt.
Saving your refund is a good idea, but not so much if you have debt–particularly credit card debt, which usually carries high interest rates of 15-30 percent. Paying off debt is one of the smartest things to do with tax refund money.
If you pay off $3,000 in credit card debt that was carrying 18 percent interest, you will save $540 over the course of a year. You’d be lucky to make $30 in interest by putting the money into a savings account, which typically earns 1 percent interest or less per year.
One note: If you don’t have any money in savings at all, you may want to put some of the money away before putting the rest towards your debt. Having a small savings for unexpected expenses that often occur is recommended by many financial experts to avoid going right back into debt again if an immediate need arises–and they always do, don’t they?
2. Avoid debt.
The best way to avoid debt is to live within your means and pay cash for things you need or want to buy. If you know you will have a large purchase or bill coming up that you would otherwise have gone into debt to pay, using your tax refund will avoid that debt along with the interest you would pay on it until you could pay it off.
3. Emergency fund.
If you don’t have debt or any large unfunded purchases coming up, you can fund all or part of an emergency fund with it. Financial experts recommend having three to six months of expenses put aside in case you or your partner becomes unemployed or a major unexpected expense occurs. While building a fund that large can seem like an impossible task for many people, it can really be a lifesaver when things go wrong in a major way.
4. Invest for the future.
There are several ways you can put your tax refund to good use by investing it for you or your family’s future. When you put money into an IRA or 401K, you will in most cases earn a better return than you could ever do in a savings account, and be able to have that money plus all of its earnings when you retire.
If you don’t already contribute to a retirement savings vehicle, you can put $5,500 into an IRA and up to $18,000 into a 401K each year and deduct it all from next year’s taxes. Roth IRA contributions are not deductible but are tax-free when you take the money out in retirement.
If saving for your kids’ college is more of a priority, you can open a 529 plan in most states, and the earnings you make on any money you put in will be tax-free if used for educational purposes like college or college expenses.
5. Invest in your own education.
Going back to school is expensive, but can lead to a raise or promotion and pay for itself over time. Even taking an online course like those at Proofreadanywhere.com or Learn to Be a Bookkeeper can provide new skills for a side hustle or new career that can bring in a lot more money than the course costs. If you need a laptop, tablet or smartphone on which to take the courses or to work when they are completed, Swappa is a place to buy gently used tech at the best prices.
6. Protect yourself.
If you normally live on a tight budget, you may not have adequate insurance to cover you if something bad happens. If you have state minimum car insurance, you may want to upgrade it to better coverage so that if an accident occurs, both you and the other party will have their needs covered, and you will be covered in the event of a lawsuit if that should unfortunately occur.
Life insurance is something that a lot of people don’t think about, but if you have a family, you should have life insurance so that they can be provided for in case you would unexpectedly pass away. Term life insurance policies are usually inexpensive unless you have chronic health conditions, so for a few hundred dollars a year, you can have peace of mind about the future no matter what happens.
Should You Adjust Your Tax Withholding So You Don’t Get a Refund?
These are some of the best ways to use your tax refund, but have you ever stopped to ask yourself why you are giving the federal government an interest-free loan each year? If your budget is tight and you are barely making it from paycheck to paycheck, adjusting the amount the government takes out of each paycheck could give you an extra $250 a month on average to pay bills or put toward one of these priorities, and you wouldn’t have to wait until tax time to have access to more of your own money.
Some people think of their tax refund as forced savings and rationalize that if they had the money each paycheck, it would just get spent and be gone. Having your withholding set so that you just about break even on your taxes, however, will allow you to be more intentional about how that money gets spent or saved. Even if you just put the money into a savings account or investment vehicle, doing so with each paycheck throughout the year allows you to make interest or earnings from that money rather than the government doing so.
If you do decide to adjust your withholding, just ask your employer to let you fill out another W-4 form and lower the number of deductions you claim–probably just by one or two so that you don’t end up owing the government money next year.