6 Smart Ways to Use Your Tax Refund

6 Smart Ways to Use Your Tax Refund

Expecting a tax refund? This is a great opportunity to jump start your finances and secure a better financial future.

It can be tempting to rush out and spend your refund on a new car or a fancy vacation. After all, it might be the single biggest check you receive all year. But remember: This was your money all along, not a prize that has fallen from the sky. There are much better uses for this chunk of cash that could actually leave you far better off in the long run.

“There are great ways to use a tax refund to invest in yourself and get on sound financial footing,” said Gerri Walsh, FINRA’s senior vice president for Investor Education.

In all, more than 70% of Americans are expected to get a tax refund this year, according to the IRS . Last year, the average refund amounted to $2,895.

If you are one of those millions of Americans expecting a refund, here are six smart ways to put your refund to work.

young man holding money in front of his face

Image source: Getty Images.

1. Pay down high-interest debt

One of the smartest things you can do with your refund is to zap your credit card debt  or to pay down other types of high-interest debt, Walsh said.

Paying down your debt with your refund bucks could yield sizable savings. By lowering your balance, you reduce the amount of interest you owe.

“Getting debt under control and out of the way quickly can save hundreds, or even thousands of dollars, over time,” said Bruce McClary, a spokesman for the National Foundation for Credit Counseling.

2. Supersize your savings

Your tax refund might help you sleep better at night if you use it to bulk up your savings. The first place you should stash it away? Your emergency fund, if it isn’t already fully funded.

Experts typically recommend an emergency fund big enough to cover three to six months’ worth of living expenses to cushion the blow of a job loss or another financial setback. But many people are woefully behind in achieving this goal. About 54% don’t have an emergency fund at all, according to the FINRA Foundation’s National Financial Capability Study .

Luckily, the IRS makes it easy for taxpayers to save their refunds. By opting for direct deposit , you can deposit your refund, for free, in up to three U.S. financial accounts. You can also direct your refund money toward the purchase of up to $5,000 in U.S. Savings Bonds.

Think of it this way: The more of your tax refund you save today, the less of a chance you’ll end up needing to tap your credit cards or take on other unnecessary debt if you hit a rough patch in the future.

3. Fund your retirement accounts

The “found money” you receive today could make a big difference in the years to come. Consider making an extra contribution to your Roth or traditional IRA . The effect of compounding  could mean that refund is worth many multiples more by the time you retire.

Remember the IRS’ direct deposit option? You can choose to have some, or all, of your refund money sent directly to your IRA. If you don’t already have an IRA, you might want to consider using your refund money to start one.

The annual contribution limit for IRAs in 2018 is $5,500 ($6,500 for those aged 50 and above).

Does your company offer a 401(k)? If so, while you’re focused on retirement, figure out whether you’re on track to save the maximum this year using FINRA’s 401(k) Save the Max  calculator. The contribution limit for 401(k)s this year is $18,500 ($24,500 if you are age 50 or above).

4. Bulk up your kids’ college funds

Once you’ve taken care of more immediate financial concerns and your retirement, it’s time to think about your kids and their future.

Two types of college savings vehicles, 529 plans and Coverdell Education Accounts , offer potential tax benefits so long as the money is used for qualified educational expenses.

You might ask why you should worry about bulking up your children’s college savings accounts if their college years are far away. The answer is that every dollar you save today reduces the chances your kids will face a heavy student loan burden down the road.

5. Invest in your career

If you’ve been dreaming of developing new skills or getting a degree, this could be your shot. You might want to invest your tax refund in yourself by signing up for continuing education courses or an advanced degree program.

The payoff might be more than just a higher paying job — it might also include personal satisfaction. That beats a shopping spree at the mall any time of the year.

6. Plan for next year

No matter how you use the cash from your refund this year, take some time to evaluate and adjust your withholdings to prevent a refund next year. Sound crazy?

A refund sounds great, but in reality, it means you overpaid on your taxes over the course of the year. A tax refund is often referred to as an “interest-free loan” to Uncle Sam. It is money you might otherwise have used during the year to pay your bills, invest, or reduce your debt. Instead, you paid that money to the government.

For many taxpayers, figuring out how much to pay in taxes throughout the year to avoid getting a refund is a difficult task. Some people deliberately withhold too much from their paychecks, using this tactic as a forced savings plan. Many others, though, experience changes in their life that impact their tax status, whether that means getting married or divorced, having a child, or changing jobs.

But if you can help it, you might be better off forgoing the refund and using the extra cash from each paycheck to invest or to pay down your debt throughout the year, rather than let the government hang on to your hard-earned cash interest-free.

Subscribe to FINRA’s The Alert Investor newsletter  for more information about saving and investing.

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