Last year, over 80% of tax filers received refunds. The average tax refund was $3,120. With tax refund being so prevalent, it’s no wonder people are searching for the best ways to use this money windfall. Whether you receive a tax refund every year or will be receiving one for the first time, you may have questions on how to best use the money. Fortunately, there are some smart strategies that’ll help you improve your financial situation. Here are best things to do with your tax refund:
1. Pay Off High-Interest Debt
The higher the interest rate on your debt, the more money you lose over time. If you have a $1,000 balance sitting on a credit card with a 15% interest rate, you’ll lose $150 in a year if you don’t pay it off. Bump that amount up to $10,000 and you’re losing $1,500 in one year by not paying it off!
In general, debt limits the freedom you have with your money. The payment that you’re making every month on your credit card or loan could be used for other financial goals like saving for a house down payment.
So, the best thing you can do with you your tax refund is pay off high-interest debt. After you’ve paid off the debt with the highest interest, work your way down to any other debts you have with lower interest rates. Those are less of a priority but should be paid off as quickly as possible to give you more freedom with your money.
2. Build An Emergency Fund
An emergency fund is a cash reserve set aside to be used in the event of a financial crisis. It’s meant to cover large unexpected expenses or to cover regular expenses in the event of a job loss. Everyone should have some sort of emergency fund – no matter how big or small.
The next best thing you can do with your tax refund is build an emergency fund. If you don’t currently have an emergency fund, start with a goal of $1,000. After that, it’s recommended that you have three to six months of expenses saved in an emergency fund. This amount should be enough to keep you covered should a large medical bill come up or you temporarily lose your job.
The best place to keep your emergency fund is in a high-yield savings account. Online banks like Capital One 360 and Ally offer competitive interest rates on high-yield savings accounts. This way, you’ll earn a considerable amount of interest on your money while you’re not using it but still have some liquidity when you actually need it.
3. Start A New Savings Account
Do you have multiple savings goals? Using your tax refund towards one of those goals is a great idea. You can even set up direct deposit into a new savings account so that all of your tax refund goes straight towards your designated goal.
I personally have multiple savings accounts for my various goals. It’s a great way to make sure you’re staying on track each month to hit your targets. If you’ve found that there’s one goal you’re slacking on or one that’s really big and could use an extra windfall, your tax refund is the perfect opportunity to get on track.
Whether that’s saving for your next vacation or for your child’s college education, using your tax refund to start a new savings account or beef up an existing one is a smart move.
4. Contribute To Retirement Savings
You can never go wrong with contributing to retirement savings. If you’re contributing to an employer-sponsored retirement plan such as a 401(k) or 403(b), you’re on the right track. You can use your tax refund to open up an individual retirement account – whether that be an IRA or Roth IRA.
If you’re currently contributing to your employer-sponsored retirement plan on a pre-tax basis, it’s probably best to open up a Roth IRA so that you can make some contributions on a post-tax basis and have a combination of pre-tax and post-tax dollars in retirement. Keep in mind the IRS annual contribution limits. Currently, you can’t contribute more than $5,500 ($6,500 if age 50 or older) per year to an individual retirement account.
5. Donate To A Charitable Cause
The last thing you can consider doing with your tax refund is donating to a charitable cause. If you’re on top of your financial goals or have done everything else on this list and still have money left over, consider sending some funds to your favorite charity.
You’ll be putting your money to good use by supporting a worthy cause. Sometimes we get so caught up in our own financial problems that we forget so many people are in even worse situations. Donating your money to a local homeless shelter or a national poverty organization would help those who are most in need get into better financial situations.
Of course, if you’re receiving a tax refund, you likely have other things you need to do with the money first. You can always donate your time to these charities instead of your money.
Whether you’re receiving a large tax refund or a small one, what you do with it is important. Choosing what you do with the money wisely can really put you ahead financially. Making the wrong decision will only keep in you in the same financial situation or even get you in more debt. Use this windfall as a chance to further your savings goals, pay off high interest debt, build an emergency fund, or contribute to retirement savings. If you’re feeling extra lofty, consider donating some of your tax refund money to a charitable cause.