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Getting an income tax refund can be both exciting and stressful, as you’ll have to decide what to do with your sudden — and possibly unexpected — windfall.
You have so many options. Should you save it? Squander it? Invest it? Some choices could improve your financial situation while others might leave you worse off.
Remember: This isn’t extra cash — it’s your own money that Uncle Sam is returning. So how can you make the most of your tax refund? Here are eight smart moves to consider and four things that you should avoid.
8 smart things you can do with your tax refund
Tax season can be taxing, so a refund could make you feel rich and inspire you to splurge on unnecessary things. Instead, consider one of these eight savvy steps to turbocharge your financial security.
1. Beef up your emergency fund
An emergency fund is a savings account that can be a cushion during events you can’t anticipate or budget for, such as a major illness, a job loss, a car accident or a natural disaster. Such a fund, especially in a high-yield bank account, is an essential part of a good financial management plan. Use your tax refund to start, build or replenish your emergency savings.
2. Pay down high-cost debt
It’s a no-brainer to use your tax refund to pay down high-interest debt, such as credit cards, a payday loan, car title loan, debt consolidation loan, personal loan or private student loans.
Lowering your debt means you’ll pay less in interest charges every month, leaving you with smaller payments. Getting rid of all your high-interest debt is a smart goal that can reap rich long-term rewards.
3. Contribute to your retirement account
Retirement might seem too far in the future to worry about now, but, in fact, time can be your friend. The earlier you save and the more you save when you’re younger, the more time you’ll have to build up your retirement savings and benefit from the magic of compound interest.
Putting your tax refund into a retirement account — 401(k) through your employer, a traditional IRA (individual retirement arrangement), a Roth IRA or another account with potential tax advantages — can help jumpstart your future financial security. In addition, you might be able to deduct some of the contributions on next year’s tax return.How to check your tax refund status
4. Invest in career-building education
Your tax refund might not be enough for a four-year college degree, but you could use it to earn a professional certificate, add a special skill to your résumé, or relocate to a city with better prospects for your career and income. Over time, a salary increase might be worth much more than the value of your refund today.
5. Save to buy a home
If one of your goals is to stop renting and buy a home, you’ll need to save up for closing costs and a down payment on the mortgage. An ample tax refund can give you a nice start on the road toward your own home and getting the tax benefits of homeownership, or take you further down the homeownership road if you’ve already started to save.
6. Increase your home equity
If you already own a home, you could use your tax refund to boost your home equity by making extra mortgage payments or applying a chunk of cash directly to the principal. Reducing your housing debt could also lower your interest expense over the term of your home loan.
7. Spruce up your home
You can also increase your property value — and thereby your equity — by using your tax refund to make home improvements and repairs so your house remains up-to-date and in good condition. Start with deferred maintenance tasks and then tackle updates and improvements.
One smart idea is to replace old appliances that are near (or beyond) the end of their useful life. Newer appliances are generally more energy-efficient than older models, so this use of your refund could make your home more valuable and lower your monthly utility bills.
8. Make a tax-deductible donation
If your personal finances are in good shape and you’re feeling generous, you could donate your tax refund to a charity and potentially deduct the charitable donation from your taxes if you itemize your deductions when you file your tax return. Giving back feels good and has societal benefits, too.How to avoid going into debt while waiting for your tax refund
4 things you probably shouldn’t do with your tax refund
Your tax refund might be the biggest paycheck you get in a year and you could be tempted to spend it hastily or unwisely. Here are a few examples of what you probably shouldn’t spend your refund on.
- Impulsive purchases of unnecessary consumer goods: Such as expensive seasonal clothing or a new car, boat or electronic gadget. That 50-inch TV might not look so good when you don’t have enough money to pay your bills at the end of the month.
- An expensive trip or dining out excessively: Create a budget that includes occasional treats, but don’t blow your tax refund on an unplanned vacation or expensive restaurant. Those things come and go, and don’t allow you to hold onto or grow the value of your tax refund.
- A checking account that doesn’t earn interest: Saving your refund is a great idea, but it’s important to choose a savings vehicle that will make your money grow. Research your investment options and try out money apps for saving and investing.
- Gambling your hard-earned cash: It’s understandable to want to try to double your tax refund at the casino, but remember that it’s very easy to lose it all.
Your tax refund isn’t just extra money you found by the roadside. It’s actually income that you earned during the tax year. And it’s money that you’re giving as an interest-free loan, albeit temporarily, to the federal government.
If you received a large refund, one reason could be that you’re claiming fewer allowances on your W-4 than you should, which causes your employer to withhold more federal taxes from your paycheck. You might want to readjust your income tax withholding and have more money in your pocket every month that you could put to better use. It’s important to plan wisely and put your refund toward smart financial goals. You worked hard for your refund. Now, your refund should work hard for you.