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What To Do With Your Tax Refund
As the tax filing season approaches, many people are looking forward to getting their tax return filed, so they can get that long-awaited tax refund check in the mail.
That envelope from the IRS comes with a big question: what should I do with my tax refund? And, perhaps just as important, what shouldn’t I do with that refund?
Here are some financially smart suggestions for using your tax refund for maximum benefit, but first, let’s talk a bit about actually filing your tax return.
You have to file your return before you get your tax refund
The first step in getting a tax refund is to file your tax return. You can handle this yourself, or you can pay a tax specialist like H&R Block to file on your behalf.
This year in particular can be tricky, as social distancing is on the minds of many people. There are a number of approaches to take for filing your taxes while respecting social distancing, but the easiest is to simply do it yourself using tax software. For many people, there are some great free tax software packages available.
If you’re a freelancer — which more and more people are these days, especially after the tumultuous changes of 2020 — there are some special strategies for tax filing for freelancers that you should follow. Also, if you’re struggling to get this done by April 15, you don’t have to stress out — it’s easy to file an extension on your taxes.
Now, what about that refund check?
6 things to do with your tax refund
Pay off debts
If you have any outstanding debts, particularly anything that might be considered high interest (anything above 8%), there’s almost nothing you can do with your tax refund that’s smarter than paying off that debt. This is particularly true if you’re committed to not getting back into debt once it’s paid off. Start by building a debt repayment plan, then use that for guidance as to what debt to pay off first.
Contribute to retirement savings
A healthy tax refund check can be a great boost to your retirement savings. You can use that check to boost your Roth IRA or, if you’re a high-income earner, you can do a backdoor Roth IRA. You can also use this as an opportunity to bump up your contributions to your workplace retirement plan, as the tax refund check will help you to be sure that everything remains financially smooth in your day-to-day life.
Start an emergency fund
An emergency fund is a great tool to keep you from sliding into debt when unexpected things happen in your life, and your tax refund is great seed money for an emergency fund. Simply open up a savings account at a new bank, deposit your tax refund in there, and let it sit until something goes bad in your life. Here’s a guide to starting an emergency fund, along with reasons why you shouldn’t trust a credit card for this job.
Save for a down payment
Many people have major life goals coming up in their life. Whether it’s buying a house, buying a car, or something else, putting that refund check aside for that big goal turns that nice check into something potentially life-changing. Just stick it in a savings account along with your other savings for that goal and that big dream you have comes just a bit closer than before.
Invest in yourself
Improving yourself, particularly when it’s beneficial for your career, is a great way to multiply the value of that check. Use the money to pay for a new professional certification or an online class, or even use it to help pay for pursuing a new degree. In some fields, there may be value in using the money to upgrade your professional wardrobe. If it’s something that can truly improve your earning potential, investing your tax refund is potentially a very valuable move.
Spend a small portion on something purely fun
While it’s a great idea to put all of your tax refund away for the future, it’s undeniably true that it’s tempting to do something really fun with it, too, and it can be hard to convince yourself to do the smart thing with it. One great solution is to put aside some small portion of it — say, 10% — for something fun, while doing something wise with the rest. If you get a $1,000 tax refund, put $900 toward something wise, then think of something truly fun and memorable to do with the remaining $100. That way, it feels good in the heat of the moment while also feeling wise in the long term.
3 things you shouldn’t do with your tax refund
While those options above are wise decisions for using your tax refund, they might not appeal to you. On the other hand, there are some things that are poor decisions you can make that you should simply avoid. Whatever you do with your refund, try to skip doing these things.
Spend it on something forgettable
It’s not inherently a bad choice to spend your tax refund on something enjoyable, but it is a bad choice to spend it on something thoughtless. If you want to spend your tax refund on something fun, put some thought into it as soon as possible so that you don’t watch it disappear on something frivolous and forgettable later. Consider things that will be deeply meaningful to you or provide lasting value in your life.
Invest it in something super-risky
While investing your tax refund is often a wise choice, investing it into something that’s incredibly risky is usually a poor choice because those types of investments rarely pay off and are tantamount to gambling. If you’re considering investing your tax refund in things like obscure cryptocurrencies or lottery tickets, consider something with a little less risk involved.
Spending it on an expensive hobby
Many people use windfalls as an opportunity to get started on an expensive hobby that will require a lot of upkeep. They’ll use it to buy golf clubs, for example, which sets them up for regular expensive green fees, or they’ll buy a video game console that will require lots of additional purchases. Before falling down that rabbit hole, ask yourself if the thing you’re buying is going to require many additional expenses to really get enjoyment out of it, and avoid those things.
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