Are you expecting a tax refund this year?
You’re in good company, as millions of Americans are in the same boat. As of early March, the IRS reported an average tax refund of just over $3,000, up three percent compared to the average refund at the same time last year.
While a refund can feel like a windfall, remember that it’s actually your money due to overpayment of taxes. Some people compare it to giving Uncle Sam an interest-free loan.
If you lack the self-discipline to save over the course of the year, then getting a tax refund may be a good way to force yourself into saving.
That’s assuming your refund actually goes to savings, which many don’t.
If you’d like to put the money to work in other ways, then you may want to adjust your payroll withholding. That way you’ll have more cash flow during the year and a smaller refund in the future.
If you already have a tax refund coming your way, here’s a look at smart ways to use it:
Pay down debt
If you have high-interest debt like credit card bills, put at least part of your refund towards your debt.
Money you put towards the principal means less money you’ll pay later on interest charges, which can add up quickly. However, because mortgages are a secured loan, the interest rates are usually lower than other types of debt.
Paying off high-interest debt like credit cards should be a higher priority than paying off a mortgage.
If your car broke down and needed repairs, would you have the money to pay for it? What about unexpected medical bills or a last-minute plane ticket to attend a relative’s funeral?
If you answered no, then you might want to sock away your tax refund in a rainy day fund. Nowadays savings accounts don’t earn much interest, but you still need some liquid funds available in case of an emergency.
Depending on your situation and how quickly you could find a new job if you were laid off, experts recommend saving three to six months’ worth of living expenses just in case.
Fund your retirement accounts
Already have a rainy day fund? Consider putting your refund towards retirement savings and letting your money grow over long periods of time. If you’re already contributing to an employer-sponsored retirement plan like a 401(k), then you might consider opening an IRA (Individual Retirement Account).
The maximum amount you can contribute to a traditional or Roth IRA is $5,000 per year ($6,500 if you’re age 50 or older).
Traditional IRA contributions may also be tax-deductible.
If you’re already saving for retirement and don’t have high-interest debt, then you might consider investing your refund. Most experts advise you only invest money you won’t need for at least five years and to diversify rather than focus on single stocks.
Of course, investing doesn’t necessarily mean buying financial instruments. If you’re hoping to advance in your career, you might invest in yourself by paying for a certificate program or a professional development course.
If your home needs repairs or you’ve been considering a few upgrades, you might invest that money into your home. Consider this article on renovations that will add value to your home.
In addition to paying down debt, saving or investing, you may feel the urge to spend your refund, too. As long as you do it intentionally and spend the money on something that brings you happiness, go for it.
Take that weekend trip you and your honey have been dreaming about, buy those boots you’ve been eyeing online, or treat yourself to that cooking class your coworker raved about.
Ramit Sethi, author of “I Will Teach You to be Rich,” recommends treating yourself with a small portion of found money. Hopefully that means you won’t feel deprived and wind up blowing the whole thing.
Tell us! How do you plan to use this year’s tax refund?