For many Americans, tax filing season marks the countdown to getting a refund: Last year, the IRS sent out almost 112 million tax refunds, with the average refund reaching nearly $2,900.
Now comes the fun part: What do you want to do with that money? There’s no right or wrong answer; it all depends on your goals and priorities. If you’re expecting cash from Uncle Sam, here are some smart things to do with your tax refund.
HAVE A LITTLE FUN WITH IT
Yes, you heard right. Set aside some of that money for a splurge to congratulate yourself for getting through another tax season. Date night for two? Family day at an amusement park? Refunds can help you spend on something fun without having to dip into your everyday budget to pay for it. In fact, whenever you receive any sort of windfall, consider setting a percentage aside for fun spending so that you get to enjoy some of that money now, in addition to using it for other goals.
START SAVING FOR A FINANCIAL GOAL
A tax refund is a great opportunity to finally start saving for that big thing you’ve been dreaming about. For instance, maybe it’s been years since you’ve had a trip abroad with the family and you’re itching to hit the Swiss Alps. Maybe you’ve been thinking about moving from your starter home to your dream house. Or maybe you just need to boost your emergency fund so you’re not caught off guard by a surprise expense.
Whatever the goal, the first step is setting aside some money for it. If your goal is short-term, meaning you think you may need to access your money within a few months or years, consider putting your goal money into a high-yield savings account, where it’ll be easier to access when you need it. (Just consider making it separate from the bank where you hold your primary checking account, so you won’t be as tempted to transfer money from your savings to your checking.)
If you’re saving for something long term, like a down payment on a bigger home you may want to buy in the next 10 years, consider saving for it in an investment account, where your money can potentially grow faster with the help of the markets. A financial advisor can also help you figure out the best way to save and grow your money based on your goals and timeline.
A tax refund is a great opportunity to finally start saving for that big thing you’ve been dreaming about.
PAY OFF HIGH-INTEREST DEBT
There’s no reason debt needs to slow down your financial progress. Use your refund to kick some high-interest-rate debt to the curb (read: those credit cards that charge you double-digit interest rates). That’s because when you pay down that debt, you’re freeing up future cash in your budget by reducing or eliminating the amount you pay in interest each month.
Let’s say you have a $2,900 balance on a credit card that charges a 20 percent annual percentage rate, and you’ve been paying $200 a month toward it. If you decide to use your refund to pay off the balance all at once, you’ll be saving yourself 17 months of payments and $447 in total interest. Plus, you’ll have $200 each month to use for something else.
But even if you decide to put just $500 of your refund money toward that balance, you’ll be shaving three months off your payoff timeline and nearly $150 off your total interest paid. That’s still money that can be freed up to put toward other, more fun goals.
GIVE YOUR RETIREMENT A BOOST
You’re likely already putting money away in a 401(k) or IRA. But it never hurts to give your nest egg a little more padding. That’s because the earlier you start saving, the longer you can take advantage of compound growth. For instance, if you’ve got $20,000 in an IRA that grows at a hypothetical 6 percent a year, in 20 years you’ll have more than $64,000 in that account, even if you never add to it again. But if you bump that amount up to $22,000, you’ll have more than $70,500 over that same time frame.
Of course, how you decide to use your refund really depends on your situation and what you’re trying to achieve. You might have one particular goal you’re really focused on, and that may be where your refund goes. Or you might put the money toward several goals, allowing you to enjoy something right now and save for something you’ll enjoy in the future. An advisor can help you figure out how to balance all the priorities you have in your financial plan.
No investment strategy can guarantee a profit or protect against loss. All investments carry some level of risk including the potential loss of principal invested.