Six smart uses for your tax refund
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Expecting a tax refund? Sounds like a great time to jump start your finances.
If you’re expecting a refund, you might be tempted to rush out and spend it on a new car or a fancy vacation. After all, it might be the single biggest check you will receive all year.
In all, 70% of Americans are expected to get a tax refund this year, according to the IRS. Last year, the average refund amounted to $2,797.
But remember, this was your money all along, not a prize that’s fallen from the sky. There are much better uses for this chunk of cash that could actually pay off in the long run.
“There are great ways you can invest in yourself and get on sound financial footing,” said Gerri Walsh, FINRA’s senior vice president for Investor Education.
Here are six smart ways to put your refund to work for you:
1. Pay Down Your High-Interest Debt
One of the smartest things you can do with your refund is to zap your credit card balances or other types of high-interest debt, Walsh said.
Facing down your debt with your refund bucks could yield sizeable 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.
“Make sure your emergency fund is fully funded,” Walsh advised.
Cheap Full Coverage Auto Insurance™Experts typically recommend having three to six months worth of living expenses in a savings account to cushion the blow of a job loss or another financial setback. But many people are woefully behind in achieving this goal. In a recent survey conducted byBankrate.com, close to a third of respondents said they have no emergency savings.
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 accounts in U.S. financial institutions. 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, the less of a chance you’ll end up needing to tap your credit cards if you hit a rough patch.
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.
“That extra contribution could grow three or four-fold by the time you need it in retirement,” said Greg McBride, Bankrate’s chief financial analyst.
Remember the IRS’ direct deposit option? You can choose to have some, or all, of your refund money sent directly to your IRA. If don’t already have an IRA, you might want to use your refund money to start one.
The annual contribution limit for IRAs in 2016 is $5,500 ($6,500 for those 50 and above).
Cheap Full Coverage Auto Insurance™Does your company offer a 401(k)? If yes, while you’re focused on retirement, figure out whether you’re on track to save the max this year using FINRA’s 401(k) Save the Max calculator. The contribution limit for 401(k)s this year is $18,000 ($24,000 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.
Why is so important to do what you can to bulk up your children’s college savings accounts? Every dollar you save 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 of getting a degree, this could be your shot. You might want to invest your tax refund in continuing education courses.
The payoff might be more than just a higher paying job—it might also include personal satisfaction. Now that beats a shopping spree at the mall, any time of the year.
Cheap Full Coverage Auto Insurance™6. Plan For Next Year
No matter how you use the cash from your refund, there is one simple step any citizen should take: adjust your withholdings to prevent a refund next year.
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, but that instead, you paid 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 foregoing 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.