Once you file your 2018 tax return, it’s time to celebrate with your refund, right? Yes, but just not the way you might think. Last year, the Internal Revenue Service (IRS) said the majority of taxpayers received an average refund of $2,800. Although spending a few grand on a big, shiny object might feel good in the moment, there are several wiser options to consider.
Instead of buying material stuff, or worse yet, trying your odds on the lottery or at a casino, the financially savvy put their tax refunds to work for them, reaping the benefits well into the future.
Plan for a rainy day
Financial experts agree that everyone should have an emergency fund that could support them for three to six months. This fund would help tide you over in the event of a layoff, natural disaster, debilitating medical issue or some other unforeseen circumstance.
In fact, NBC News asked various financial advisors how best to spend a tax refund, and they all agreed that an emergency fund “is the first place you should park your refund dollars.” This reflects the fact that too many people have nothing or too little stashed away for an emergency. In fact, GOBankingRates found that a majority of adults don’t even have $1,000 in a savings account.
To determine how much you need in your emergency fund, consider all your routine monthly expenses, including housing, utilities, media subscriptions, food, car payment and/or transportation costs, childcare, insurance and debt payments. Tally up all these expenditures and multiply the sum by at least three. If you don’t have that amount of money socked away for a rainy day, use all or part of your tax refund to build up your savings and your peace of mind.
Pay down your debt
A high-interest debt load is one of the biggest hurdles to building wealth, and it is just as problematic for people as the lack of an emergency fund. According to Experian’s State of Credit, the average person has $8,195 in credit and retail card debt. Both NerdWallet and Intuit suggest that paying off such debt is the single smartest thing that you can do with your tax refund.
Although parking your refund in a safe investment (other than your emergency fund) might make sense for some, the TurboTax team explains why paying off debt is the smarter move for most. “It doesn’t make much financial sense to put the IRS check for $3,000 in a fund yielding 1% interest and maintain a $3,000 balance on a credit card charging 18% interest.”
If credit card debt is not an issue for you, consider making an additional mortgage, home equity line of credit or student loan payment with your tax refund. Assuming there are no pre-payment penalties, this will save you money over the life of the account.
Invest in your golden years
Given that approximately half of American households have no money set aside for retirement, putting some of your annual tax refund into a traditional or Roth IRA is another smart move. The Motley Fool notes that adults under 50 can put as much as $6,000 a year into this type of tax-deferred account, while those 50 and older can contribute up to $7,000.
Such a contribution yields three key benefits to your financial health:
- A 2019 IRA contribution reduces your 2019 taxable income
- The typically lower retiree tax bracket reduces the tax on post-retirement IRA distributions
- An IRA compounds over time, increasing the value of your account the longer you own it
Improve yourself, your life or your home
Still looking for a smart way to use your tax refund? If you don’t want or need to put your money in the places described above, at least consider a strategy that pays you back over time, rather than leaving you with nothing:
- Take a class or acquire a certification that helps you earn more money or a promotion
- Contribute to a Health Savings Account that helps fund uninsured medical expenses
- Install energy-efficient appliances or greener home features that can lower both your taxes and utility bills while also increasing the value of your home
On the surface, these suggestions may not sound as exciting as spending your refund on an exotic vacation or as easy as just putting it into your checking account to cover routine expenses. But the peace of mind and financial stability that smart investing brings will pay the savvy tax filer big dividends for years to come.