Each year, millions of Americans look forward to that magical day when they find out how much they will be getting back in a tax refund. Now that the federal government and most of the states use direct deposit, people are getting their refunds faster than ever.
You could take your tax refund and buy some of the newest electronic gadgets with it or put it towards your dream vacation to Aruba. Your other option is to do something smart with your money that will eventually allow you to do these things many times over in the future. After all, this isn’t free money. It’s simply extra money you paid the government that you’re finally getting back, so blowing it on something frivolous may not be the wisest decision. While it’s always nice to treat yourself, if your financial house isn’t completely in order, here are a few ideas for how to spend your tax refund this year.
Pay Down Debt
One of the reasons that you never seem to have cash when you want it is because you tie your money up by paying credit card bills each month. Just lowering the balances you owe on your credit cards will lower your monthly payments and free up more money. If you have enough of a tax refund to pay off some of your credit card debt, then do that first.
After that, you should apply the rest of your refund towards paying down the cards with the highest interest rates. Those high interest rates mean that you are paying more to finance your card than actually use it. Paying those cards down will put a big dent in your debt. Think of it this way. If you have a credit card with a $2,000 balance with a rate of 20% and you’re only making the minimum payment each month, paying that balance off with your tax return essentially gives you a 20 percent return on your money. Where else will you find that kind of return on your investments?
Put It Into Savings
When the car breaks down, most people reach for the credit card to get it fixed. The endless cycle of paying down debt and then running it back up costs you a lot of money in service charges and interest. To stop that cycle, you need an savings account you can access to pay for repairs and other things when your paycheck is not enough. It’s called an emergency fund for a reason.
Start a savings account with your tax return and then add a little to it each time you get paid. After a while, the money you save in lower monthly credit card payments allows you to buy more things in cash and keep you out of the debt loop. Plus, if you park your money in a high-yield online savings account you can actually make a little money.
A tax refund of $2,000 can turn into $3,000 or $4,000 over time if you invest it properly. There are several investment vehicles you can use to turn this year’s tax refund into next year’s down payment on a new house. If you haven’t been maxing out your IRA, that’s an obvious first choice. If you don’t even have a retirement account, this is a perfect excuse to start one. In fact, the IRS encourages people to make retirement plan contributions with their tax refund by allowing you to have the refund directly deposited into an IRA.
Fix Up Your Home
Energy efficient windows and doors will save you money on your home energy bills and may even qualify you for tax breaks next year. Paying to have your home insulated by a professional will pay for itself in no time and start turning a profit for you for years to come. Instead of blowing your refund on a television that looks good in one room, you should spend that money on home improvements that will increase the value of your home and cut down on your utility bills. And if you have any other home improvement tasks on your to-do list, a tax refund is a good start. You’re adding value to your home and improving your quality of life.
Invest In Your Kids
Does your family really need a new television set? Could that brand new stereo system wait just a little while longer? For just one year, you should put your tax refund into a safe, long-term investment that you can use for your kids when they get older. It could help pay for college, braces or help you get your child that first car. For college, a 529 plan is a solid bet because it comes with additional tax benefits. But even setting some money aside in a separate account so that it’s available for your kids in the future is a good start.
When people get a huge tax refund, their first inclination is to go out and spend it on items that can be classified as frivolous. Rather than wasting that money, you could put it to good use for you and your family and improve your financial situation in the process.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.