Hurray, you finished filing your taxes and are getting a tax refund! If you don’t need the money for essentials right now, you might feel an urge to use it to treat yourself. But you know that there are smarter things to do with this cash. Here are 10 ideas for what to do if you receive a tax refund this year.
- Create an Emergency Fund
Life happens, and so do unexpected emergencies. These unanticipated expenses and circumstances, like losing your job, can drastically cut into your budget and affect your ability to keep up with monthly bills. Building and keeping an emergency fund is one way to be better prepared when it comes to unexpected costs and disruptions to your life and budget. The general rule is to have three to six months’ worth of expenses set aside. Even if your emergency savings are close to zero, any amount will help and provides a great foundation to build upon.
- Pay Off High Interest, Variable Rate Debt
The Federal Reserve has been hiking interest rates for the past year to fight inflation. That’s made borrowing more costly than it was when rates were pegged at zero. If you have credit card debt, consider using your tax refund to pay that off first. It may not be the most fun thing to do with a tax refund, but your future self will thank you.
- Buy Series I Savings Bonds
Did you know you can buy up to $5,000 in paper savings bonds with each year’s tax refund? While inflation has come down a bit, it still is elevated, and I Bonds can help protect against an unexpected spike in future inflation. For savings bonds issued November 1, 2022 to April 30, 2023, the current yield is 6.89%. To buy paper savings bonds, you can use IRS Form 8888 to specify how much of your refund should go to savings bonds and how much should go directly to you (by check or by direct deposit to your bank account). For more information on Series I Savings Bonds, read our prior post on this topic here.
- Boost Your Retirement Savings
Retirement might seem like a long way off. But don’t let that fool you into thinking it is. Are you on track with saving enough money for when that time comes? An additional $2,000 a year invested in a diversified portfolio that grows 6% a year can become more than $100,000 in your nest egg after 25 years.
- Invest
Want to know one way to build wealth that lasts? Invest your tax refund. Let that money, and the money from future tax refunds, grow and you’ll put yourself on the path to financial independence. Investing some or all your tax refund could help build a fund to save for some longer-term financial goals. Whether it’s a downpayment for a house or a family trip, this can help you finance spur-of-the-moment expenses without overspending, dipping into your monthly budget, or going into debt.
- Start a College Fund
Do you have children or grandchildren? Have you been putting money away for their college education? The price of higher education is expensive and not likely to get any cheaper. Consider investing in a tax-advantaged vehicle, such as a 529 plan, well before your child or grandchild heads off to college. Tax benefits include tax-free earnings and withdrawals for qualified educational expenses, and some states offer additional tax breaks. Starting a college fund when the child is young can help give you some peace of mind that you’ll be able to help with a portion of these costs when they reach college age.
- Help Others
If you feel like you are on track with all the items on this list so far, you could give your tax refund, or a part of it, to charity. Consider donating to an organization in your community that you connect with. Charities can use all the help they can get, and it may help lower your tax liability for the current year.
- Adjust Your Tax Withholding
A tax refund is like an interest free loan to the government since it’s really a return of money you could have kept and used during the year. In a zero-interest rate world this wasn’t a major issue. Now that interest rates are much higher, it no longer makes sense to loan the government your money when you could have earned interest on it during the year simply by putting into a high yield savings account or money market. For help on how much to adjust your withholding use the IRS’s tax withholding estimator or consult with your tax preparer.
- Make Some Home Improvements
Your tax refund likely isn’t going to get you a new kitchen or bathroom, but it can open the door to smaller remodeling projects that are on your home improvement to-do list. Have you put off replacing an old water heater or refrigerator? Spending some of your refund around the house on appliances that use less energy can help lower energy bills. Replacing old windows can also improve the efficiency of your air conditioning in the summer and heating in the winter. Depending on the improvements you decide to make, that investment might pay off down the line when you decide to sell your home.
- Treat Yourself
If you have tackled all the items on this list, now it could be worth it to considering in something fun. After all, money is simply a tool, so you should be able to enjoy it while also being financially responsible.
The Bottom Line
It’s easy to see a tax refund as extra spending money, but this usually isn’t the best way to use it. These suggestions may not be as exciting as spending your refund on an exotic vacation, but these moves will provide benefits for years, and help put you on the path to financial independence.
Presented by Carl Holubowich, CFP®
