8 Responsible Ways to Use Your Tax Refund This Year
You’ll thank yourself later.
If you know when tax season is, you probably also know that filing your tax return often leads to a tax refund a few weeks later. The size of your tax refund depends on a huge range of factors—including how much money you made last year and how many dependents you have, if any—but many people receive at least a little money each year.
If you’ve received a tax refund in the past, you know how that money can feel like a pleasant surprise or a bonus. According to a new survey from NerdWallet, people expecting a 2019 federal tax refund this year predict they’ll receive $2,207, on average; that’s a solid chunk of no-strings-attached cash.
In prior years, you may have treated your refund (whatever its size) as a surprise gift and spent it on a vacation or a big purchase you otherwise wouldn’t have been able to comfortably afford. If that was you, it’s time for a hard truth: Treating your tax refund as a total windfall you can spend on whatever you want isn’t a good financial decision. (And that’s ignoring the fact that the money is technically a result of you overpaying on taxes throughout the year.)
They may not be glamorous or exciting, but there are smart, responsible ways you can put your tax refund to work for you—ways that can actually earn you even more money or otherwise set you up for future financial success. If you can resist the impulse to spend your tax refund on unnecessary splurge items, you can make some positive money moves; it just takes a little restraint and some financial know-how.
Even if you feel pessimistic about the likelihood of receiving a tax refund this year—NerdWallet’s survey found that only 51 percent of filers expect an income tax refund at all—it doesn’t hurt to think about what you might do with a refund. This could be the year you straighten out your finances, after all, and one (or several) of these smart uses for your tax refund could be the first step.
Cash savings—aka an emergency fund or a rainy day fund—make up one of the basic pillars of good financial health. This fund serves as a back-up in case of the unexpected and offers a cash cushion to protect you from having to go into debt to pay to fix a broken car, for example, or unexpected home repairs. If you don’t have any money set aside for emergencies, use your tax refund to start a savings account that you only use if there’s a real crisis. Any cushion is better than nothing, and this first deposit could help kick-start your savings. If you have a small rainy day fund set aside, consider adding to it to be better protected against the unexpected; many financial experts recommend saving three to six months’ worth of expenses in an emergency fund.
Figuring out how to get out of credit card debt isn’t easy, but doing so can take a huge strain off your finances. If you have a small amount of money set aside in an emergency fund and are carrying high-interest debt on your credit card, use your refund to pay that balance down. Even if you can’t eliminate the debt completely, reducing it will help reduce the amount of interest it’s collecting and help you pay off the total debt more quickly.
If you have student debt, making extra payments can help shorten the amount of time it takes to pay back your (likely large) loan. As with credit card debt, reducing the principal, or the initial amount of money you owe, decreases the amount of interest (extra money on top of the amount of the loan) you’ll have to pay off over time. Even one extra payment a year with your tax refund can help; just talk to your lender or servicer to ensure your extra payment goes toward the principal.
The same concept applies to mortgage payments: If you have a mortgage, applying a lump sum payment (your tax refund) can reduce your outstanding loan balance, reducing the total amount you’ll owe in interest over the life of the loan.
If you’re saving for a child’s college education (or a grandchild’s), a 529 plan can make paying for the expense a little easier. 529 plans have huge contribution limits, so adding your tax refund to any contributions you’re already making is only a good thing.
If you’re eligible for a Roth IRA but don’t already have one established, tax season may be the time. (If you already have one, this windfall can be a great addition to it.) These accounts are tax-sheltered, so any investment earnings they earn can be withdrawn tax-free in retirement, and they make an excellent accompaniment to any employer-sponsored retirement savings plans you participate in. Roth IRA contribution limits are relatively low ($6,000 in 2020, or $7,000 if you’re 50 or older), so you’ll want to ensure you’re not surpassing that limit, but adding your tax refund to your retirement savings is one smart way to put that money to work for you, even if you won’t reap the benefits for a few years.
If you’ve already entered the world of investing, tax season is a good time to take stock of your investments and check that they’re moving you closer to your financial goals. Make any necessary course corrections and use your refund money to expand your portfolio. If you’ve been trying to figure out when to start investing, a tax refund can be your initial deposit into an investment account.
If you like the idea of your money working for you but aren’t sure about investing, consider a certificate of deposit, or CD. These financial products are virtually risk-free and offer higher interest rates on your money. The catch is that you can’t touch the money until the end of the term of the CD (unless you choose a no-penalty CD), but your refund money will grow more in a CD than it would in a savings account.