When tax time rolls around, you are likely waiting for that tax refund to come in, or maybe you already received it. Chances are it is a good chunk of change too. In fact, according to the 2020 IRS Filing Season Statistics, the IRS issued 125.8 million tax refunds, which totaled to more than $320.8 billion. The average refund was $2,549.
The question you should ask yourself is, should you spend the money (foolishly or smartly), save it, or invest it?
So You Got a Tax Refund?
Choosing how to use your tax refund can be challenging. Many Americans have to make this decision, and you might be one of them.
Chances are you will want to spend at least some of your refund. If so, do it the smart way. Sure, thoughts of taking an exotic vacation, buying that high-tech flat-screen TV and entertainment center, or purchasing those brand new designer shoes you have been eyeing are tempting. However, avoid this kind of foolish spending or at least don't spend the entire refund check on things like this.
Smart Uses of Tax Refund
There are smarter ways of spending your tax refund that will help you get ahead in life and give you more peace-of-mind. These include:
Setting up an emergency fund. An emergency fund is your safety net. You should have at least three to six months’ worth of expenses in this fund. That will help keep you out of debt and pay for unexpected expenses.
You may have had to use this emergency fund money over the past couple years to get yourself out of a financial downfall. That is okay, but you should replenish it. Your tax refund is a great way to get that money back in that account. You may even earn interest on it.
Paying down your credit cards. If you have credit card accounts that have large balances, you can lower your interest rates on them by paying them down. These tiny pieces of plastic you carry around in your purse or wallet are likely your most expensive debt. You can use your tax refund to get those balances down and reduce your interest.
Investing for retirement. Another smart use of your tax refund is to put it towards your retirement fund. You can use it to up your 401k contribution or invest in a Roth IRA. Either way, money in these accounts can grow tax-deferred, or be withdrawn tax-free, in the case of the Roth IRA.
Saving for college. It is hard to save for your child's college and save for your retirement at the same time. Your tax refund gives you the opportunity to fund a 529 account that can pay for college bills. Plus, they are federally tax-free, and generally not subject to state tax when used for the qualified education expenses of the designated beneficiary. Moreover, it may even lead to a state income-tax deduction.
Making home improvements. Even though you probably won't be able to do a complete bathroom or kitchen remodel with your tax refund, you can use your IRS check to make smaller home improvements. Some ideas may include:
- Painting a room.
- Swapping out your faucets.
- Replacing your bathroom sink.
- Installing a programmable thermostat.
- Organizing a closet.
- Sprucing up your landscape.
- Investing in energy efficient appliances.
These are only some ideas. There are plenty of smaller projects you can do with your tax refund to improve your home.
Avoiding Overpayment of Taxes
Make this year your last year of receiving tax refunds. Although it is exciting to receive this yearly check or deposit, it costs you. Each day you wait for that check, you could invest the funds in your retirement or other savings account and be earning interest.
Although your tax refund appears to be money in your pocket, it means that you had more withdrawn from your paycheck than you needed to. When you 'pre-pay' the government you do not receive any interest on the amount withheld. The government has access to and can use the money you pay in as they see fit, you cannot.
If you make a choice to stop overpaying on your taxes so that you can eliminate your tax refund, your first step is to contact your human resources department. They can work with you to update your tax forms. You can use your past tax years to help you estimate your deductions. While you might not be able to eliminate your tax refund altogether, you can get higher paychecks and lower tax refunds. This way you can use your money at your discretion throughout the year instead of having to wait for your tax return.
It is entirely acceptable to splurge a little on yourself, of course. You should have some fun or enjoyment with your money. So go ahead and have the nice dinner or buy that new television. You may want to forget the new car or luxury cruise though.