Wrapping up tax season comes with a huge sense of satisfaction, especially when you find out you’re getting a nice big refund from the government. But before you hop online and book a ticket to your favorite vacation spot, take a moment and consider all the ways you could use those extra funds.
Here are six ideas on how to use your tax refund that can make a lasting impact.
1. Pay down high-interest debt
Hanging onto high-interest debt like a large credit card balance can create a constant nagging feeling in the back of your head. And it can end up costing you a lot, especially if you usually opt to just make the minimum payment each month.
Consider this: Say you have a $5,000 balance with a 15% APR. Each month, you make a minimum payment of $113. At this rate, it will take more than five years to get rid of that balance and you’ll end up paying over $2,300 in interest. But if you use your tax refund to pay off just $2,500 of that same balance and continue with a monthly $113 payment thereafter, you’ll be done in just two years and will only pay $444 in interest. That’s a huge savings of nearly $2,000!
When making a debt payoff strategy, focus on your credit cards and loans with the highest interest rates in order to save the most money.
2. Start your emergency fund
Growing your emergency fund is another smart way to use your tax refund. It’s typically recommended to have at least three to six months of expenses set aside in an accessible savings account. That way if you’re laid off or have some other type of personal emergency, you’ll be prepared to cover your expenses without worrying too much. In the wake of the COVID-19 pandemic and all of the economic uncertainty that came with it, some recommend setting aside even more cash — up to a year of living expenses.
Do a quick analysis of how much you have set aside for life’s surprises to determine if you need a little more buffer. It’s a delicate balancing act of giving yourself that financial safety net without sacrificing the potential to earn more in interest and gains with other financial vehicles. But if you haven’t even met the bare minimum of an emergency savings fund, the post-tax season is the perfect time to give your account a boost.
3. Invest in your home
Taking on a home renovation project can make your house more enjoyable to live in and it also has the potential to increase the property value. Plus, you can save money by paying cash instead of taking out loan products that are often used for upgrades, such as a home equity loan or home equity line of credit (HELOC). While rates are often competitive, these financing options do use your home as collateral. So if you face a financial emergency in the future and fall behind on payments, you could face foreclosure.
Instead, cash from your tax refund could cover some or all of the costs of your next renovation. And with a little strategy, you could even increase the value of your home. Some of the projects with the biggest ROI when it comes to building home equity, include a bathroom upgrade, kitchen refresh, exterior improvements and landscaping, and deck, patio, or porch addition.
4. Make progress on your big financial goals
Your tax return can help you either catch up or increase your investments for the future. You can do this in a number of ways, including:
- Funding your retirement. Investing in a tax-advantaged retirement account helps your financial future and it may also help lower your tax burden for next year. Remember that eligible 401(k) and Traditional IRA contributions are tax-deductible, so it’s a win-win in terms of growing your nest egg and lowering your taxes for next year.
- If you qualify for Roth IRA contributions, you won’t get a tax deduction, but you’ll set yourself up for tax-free withdrawals when you do retire or use the funds for other eligible purchases.
- Investing in a taxable account. Not all of your tax return needs to be invested in a retirement account. Consider contributing to a balanced portfolio in a taxable investment account. This strategy could work well for your mid-term savings goals that are at least a few years away.
- Saving for your kids’ college education. Whether you have a baby or a teen nearing college age, you can use your tax refund to increase your child’s college savings fund. For instance, when you invest in a 529 Plan, you may qualify for a state tax deduction (depending on where you live). And when it’s time to withdraw funds, any funds used for eligible education expenses are tax-free.
5. Invest in yourself
You are your greatest asset, so it makes sense to use some of your tax refunds to invest in yourself, particularly if you already have a solid financial foundation in place. Perhaps you want to take your career to the next level, learn a new skill, or brand out in a completely new direction. Using your tax refund can help pay for a variety of development opportunities, such as:
- Earning a degree, professional certification, or taking college courses in the future (If so, open a 529 plan to potentially save on your State taxes.)
- Taking a skill-building course
- Attending a professional conference
- Launching a side hustle or small business
Whatever passion you’ve been wanting to explore, you could use part of all of your tax refund to finally jump in.
6. Give back through charitable contributions
A final smart strategy for spending your tax refund is to do some good by giving part of those funds to charity. It’s a wonderful way to exercise your personal values by choosing a cause or organization that you’re passionate about supporting.
And you don’t have to give away your entire tax refund. Choose a set amount or percentage that feels comfortable with your other financial goals. That way you can help others while you also help yourself while getting a head start on lowering next year’s tax bill with a potential donation deduction. After all, financial planning for things like taxes and charitable contributions should be on your radar all year long.