9 Smart Ways to Use Your Tax Refund

9 Smart Ways to Use Your Tax Refund

It’s that time of year when people are getting their tax refunds. Maybe you’ve already received yours or maybe, like me, you’re still waiting on it. Or maybe you still need to file your taxes. (If that’s you, get on it! The deadline is April 15.)

Wherever you stand, your tax refund is a good opportunity to make big progress towards one or more of your financial goals.

So, how can you make the most of that money? Below are nine ideas that can help you secure your financial foundation and build towards the future.

By the way, these same ideas apply any time you have a sudden influx of money. It could be a bonus, a gift, some side income, proceeds from a yard sale, an inheritance, or something else.

No matter the source, you can come back to this list whenever you’re unsure how to make that extra money work for you.

1. Start with your personal goals

While there are lots of things you could do with your tax refund, the right move or combination of moves always depends on your personal goals.

So before you do anything, I would start by stepping back and reminding yourself what, exactly, you’re trying to achieve. Why is money important to you? What opportunities do you want it to create for yourself and your family? What kind of life are you trying to build?

If you don’t already know the answers to those questions, try using the following process to get some clarity: A Life-Centered Approach to Setting Financial Goals.

Financial planning is all about creating a happy, healthy life for you and your family, both now and in the future. Reminding yourself exactly what that means to you will help you make better financial decisions.

2. Build an emergency fund

An emergency fund is simply money, sitting in savings, available for the unexpected. And it serves two important purposes:

  1. It provides security by making sure there’s cash available for emergencies and other unexpected expenses.
  2. It provides the flexibility to do things like change careers, switch to a single income, or start a business because you have the savings to smooth out the inevitable bumps in the road.

Your tax refund is a great opportunity to bolster your emergency fund. Here’s more on how to do that: A Comprehensive Guide to Building Your Emergency Fund.

3. Pay off debt

Using your tax refund to pay off a big chunk of credit card debt, student loans, auto loans, or any other debt all at once can provide a huge boost to your finances.

First of all, it’s a great investment. If you have a credit card that’s charging you 18%, every extra dollar you put towards that debt earns you an immediate and guaranteed 18% return. That’s hard to beat.

Second, it saves you money. Less debt means less interest, which means more money in the bank.

Third, it gets you closer to being free from the financial obligation you have to your lender. Once that debt is gone, you no longer have the obligation to dedicate a set amount of work hours to paying it back, which gives you more freedom to spend your time and your money as you please.

Paying off high-interest debt – which I generally define as any debt with an interest rate of 6% or above – is an especially good move. It’s honestly hard to beat in terms of efficiency and effectiveness.

4. Contribute to an IRA

IRAs are tax-advantaged retirement accounts that you open up on your own, outside of your employer. There are two types:

  • Traditional IRA – Your contributions are tax-deductible, the money grows tax-free inside the account, and the withdrawals you make in retirement are taxed.
  • Roth IRA – Your contributions are not tax-deductible, but the money still grows tax-free inside the account and you can make tax-free withdrawals in retirement.

There are pros and cons to each type, but the bottom line is that contributing to either one will help you build towards a better financial future.

My wife and I have all our IRAs with Vanguard, though there are plenty of good providers you can use. Just make sure to pay attention to the income and contribution limits before moving forward.

5. Increase your 401(k) contributions

While you can’t directly contribute your tax refund to your 401(k) – since all contributions have to come out of your paycheck – it can still help you increase that contribution without disrupting the rest of your financial needs.

Here’s how to do it:

  1. Put your tax refund into a savings account.
  2. Divide the amount of your tax refund by the number of months left in the year.
  3. Increase your monthly 401(k) contribution by the result you got from Step 2.
  4. Withdraw from your savings account as needed to make up for the decrease in take home pay.

As an example, let’s say that you receive a $2,400 tax refund. You can put that money into a savings account and increase your 401(k) contribution by $300 per month starting in May ($2,400 divided by 8, since there are 8 months left in the year). Then you can move $300 per month from your savings account to your checking account, leaving you with the exact same amount of spending money each month even though you’re contributing more to your 401(k).

This is an especially effective strategy if you aren’t yet taking full advantage of your employer match. In that case, you may be able to effectively double your tax return through the combination of your contribution plus the match.

6. Fund future expenses

There are all kinds of things that you may either want or need to spend money on in the near future, and your tax refund could be a good opportunity to fund them.

Maybe you’re trying to save up for a down payment on a house. Or maybe your current home is going to need some upgrades in the near future. Or maybe you’d like to be able to travel to see friends or family.

Any big future expense will be easier to handle with a big infusion of cash.

7. Treat yo’ self

If your big goals are already on the right track, then you should absolutely feel free to use at least some of that tax refund to treat yo’ self.

Plan a weekend getaway. Go out for a fancy date night. Buy that espresso machine you’ve always wanted.

Money is supposed to make you happy, after all. So if your financial foundation is already secure and you’re already making good progress towards your most important future goals, go ahead and spend it on something that you’ll enjoy.

8. Pay it forward

As important as it is to focus on the health and happiness of you and your family, there are plenty of other people who could use a helping hand as well.

If you already have enough to meet your family’s needs, you could always consider using your tax refund to support one or more causes you believe in. It’s a great way to do some good in the world, and there’s even scientific evidence that it can increase your own happiness as well.

9. Consider adjusting your withholding

If your tax refund is really large, you could consider adjusting your withholding to have less taken out of your paycheck so that you’re able to put that money to work a little sooner.

From a pure math standpoint, this strategy makes a lot of sense. Simply put, you’re better off earning interest on that money now than you are waiting until next year to get it.

But it’s more complicated from a behavioral standpoint. Because you’re also much better off waiting to get another big windfall next year and doing something productive with it than slowly spending it each month instead.

So if you do decide to adjust your withholding in order to increase your take home pay, just make sure you have a firm plan in place for doing something productive with that extra money. Automating it to a savings account is an easy way put it to work and ensure that it’s helping you reach your goals.

Make the most of it

Wherever you stand right now, your tax refund is a great opportunity to make big progress towards your most important personal and financial goals.

I hope the list above helps you make the most of it. And if you have any questions, please feel free to ask in the comments below. I’m always happy to help!

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