Tax season is over, and you might have an addition to your bank account in the form of a tax refund. Before you spend it all in one place, take a step back and think about what this money could do for you.
“I don’t care about getting a big tax refund,” says Glen Craig, the owner of FreeFromBroke.com. He points out a tax refund is evidence that you’ve been giving the government an interest-free loan. However, he also understands that, for many people, a tax refund feels like a windfall, and that the money can be used to improve your financial situation.
While it might be tempting to spend the money on something fun, you might first want to consider putting that money to work on your behalf instead.
Pay down high-interest debt
“Pay down credit cards carrying a balance,” suggests Craig. “You reduce your debt, so you aren’t paying as much in interest.”
If you have a credit card that’s charging you 17.99% interest, it’s like getting a substantial return on your money when you pay down that debt. Think about what you could do if you weren’t paying that interest into someone else’s pocket.
It may not be as effective to pay down other types of debt, however. Craig says that it can make sense to pre-pay on your mortgage or tackle your student loan debt, but the effects aren’t as large. “These types of debt often have much lower interest rates, and they are tax-deductible, so your tax refund doesn’t go quite as far.”
For those who have goals to be debt-free, and who have already gotten rid of other high-interest debt, it can make sense to reduce the low-interest debt next. But before you assume that you have to get rid of all of your debt to get your money working for you, stop and think about what you could gain by investing the money.
Earn interest from your tax refund
“Investing is a great use of your tax refund,” says Craig. “You have the potential for higher returns, and you can shore up your finances a little more.”
One of the best things you can do with your money is put it in a tax-advantaged account. If you haven’t reached your contribution limits for your retirement account, add your tax refund money. You can open an IRA or even put the money in a Health Savings Account (if you qualify). These types of accounts come with extra advantages that will help your money grow more efficiently.
It’s also possible to help your child by contributing to a 529 plan. Craig recommends checking your state law and your state 529 plan. Even though there aren’t federal tax benefits for 529 plan contributions, many states offer their own benefits.
“Don’t forget about your emergency fund,” says Craig. “If you don’t already have an emergency fund, your tax refund is the perfect way to get one started.”
For those who already have emergency funds, a little addition from the tax refund can boost its effectiveness. “In many cases, a tax refund can amount to another month’s worth of expenses, or enough to cover the cost of a car repair or an appliance replacement,” Craig points out.
Another way to invest your tax refund is to invest it in yourself. Craig recommends starting a small side business as one way to turn your tax refund into something that keeps producing for you down the road. He also points out that there are other ways to invest in yourself, such as taking a college course to improve your skills and knowledge so that you qualify for higher pay.
“You can also look around at your situation and see what could benefit your lifestyle,” says Craig. “Could you use better flooring in your home? Would buying a different car ensure that you have a reliable way to get to work? These are considerations for your tax refund as well since they have the potential to lead to an improved situation.”
What about having a little fun?
Of course, you don’t have to use your tax refund just for the practical things. While it’s a good idea to put at least some of your tax refund to work on your behalf, there isn’t anything wrong with taking a portion of the money and using it for something unnecessary. In fact, in some cases it’s the fun expenses that yield returns in terms of memories and emotional ties. Use some of that tax refund money to create memories that your children can take with them, or use it to go on a romantic getaway with your life partner to rekindle your relationship. These emotional investments can sometimes matter more than money.
“Put a portion of the money toward a vacation, or toward a family purchase that everyone is looking forward to,” says Craig. “You don’t want to blow all your tax refund money on something frivolous, but life isn’t any good without a little fun.”