After the scramble of preparing and submitting your taxes, we all look forward to receiving a tax return, that is if you don’t owe money to the IRS. Depending on the financial guru you ask, they will give you varying opinions on whether it is good or not to receive a tax return.
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Despite this, you may be faced with the issue of how to use your tax return. There are a multitude of places that it could go and you want to be the best steward of this cash that has found its way into your bank account.
The ideas in this article will serve as a starting point in helping you determine where you should use your tax return.
Best Ways to Use Your Tax Refund
Rebalance Your Finances
When receiving any lump sum of money, it is great to have a plan beforehand. Your tax refund is a great opportunity for you to get reacquainted with your finances if you have fallen off or determine if there are any holes or room for improvement in your finance strategy.
Throughout the year there may have been expenses that were unexpected and you didn’t prepare for. You may have borrowed from another category in your budget that you weren’t able to easily cash flow or taken out a loan to cover a larger expense.
It is time to identify those holes and determine if they can be patched with your tax refund. If they can, that is great and you can do it when you receive your refund.
However, there may be too many or too big of holes to fix with one refund. If that describes your situation, I encourage you to keep exploring this list.
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Pay off high-interest debt
This is a great option for you to choose to use your tax refund. When paying off debt, the journey can be long and test your patience.
You are actively losing money when you are in debt, so it is understandable that anyone would want to use a tax refund towards paying off debt faster.
If you are going to pay off debt, it is important to put it towards the debt you carry with higher interest rates. This is known as the avalanche method of paying off debt and you will save a lot more money in the end.
Credit card debt is the first thing that comes to mind because it is characterized by the high-interest rates and fees.
Paying off credit card debt faster makes it easier to get out of debt completely because you won’t be continuously hit with the high-interest rates every month.
Other examples of high-interest debt can be student loans, payday loans, personal loans, and car loans.
A great way to determine if a debt that you have is high interest or not is to compare it to a conservative return of the US Stock Market. The stock market usually returns about 7% over the long term, so if your interest rate is higher than that it is probably a high-interest debt.
If your interest rate on your debt is higher than the traditional return rate of the stock market, your money will better serve you being put towards debt. You would be losing money if you tried to invest and pay only the minimum towards your debt.
If you would like to make this comparison yourself, you can use a loan payoff calculator and an investment calculator to estimate the difference.
The loan payoff calculator would tell you the total amount of money you would pay over the life of a loan. The investment return calculator will tell you the total return of the cash you invest that would have been put as extra towards your debt.
Note: The time period would be the length of the loan.
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Create a Month Ahead Fund
A month-ahead fund is a great way to use your tax return. This fund will allow you to have your next month’s bills covered in the current month.
The biggest benefit of having a month-ahead fund is the peace of mind that it brings. You don’t need to worry about due dates or when your bills will be withdrawn from your account.
Creating a month-ahead fund is great because it makes you consider the amount of money that you need to sustain yourself monthly. Having this necessary cushion will make it much easier to create a financial plan and improve your financial health overall.
This fund also allows you to wristband any short-term delays that may happen with your income during the month. It makes these delays inconveniences rather than disasters that put you further into debt.
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Contribute to your Roth IRA
If you ever have spare cash and are eligible to contribute, your Roth IRA is a wonderful place to begin. This tax-advantaged account will allow you to save for retirement using after-tax dollars.
The thing that you must consider with an IRA is that you only have a limited time to contribute each year. Once the time period ends, you will no longer be able to get the time back.
A fundamental component of investing is compounding and you need a long time period for this to take effect on your investment returns.
Before you contribute to your Roth IRA or any retirement vehicle, you must consider whether you will need that money. Do not put money towards retirement that you will need in the short term. There are special cases in which you may use your retirement savings without penalty; however, it is rarely ever worth it.
Taking away from your retirement disrupts the compounding process and disrupts your returns in the end.
You may start withdrawing from your Roth IRA at age 59 ½ without penalty.
Some great companies to open a Roth IRA with are:
- Vanguard
- Fidelity
- Charles Schwab
Continue Your Education
One investment that people can forget to make is the investment in their own knowledge or education. For some people this may look like a formal university; however, continuing your education can be many things.
Investing in yourself and your own knowledge is a great way to not only increase your income but to become more financially savvy. Continuing your education exposes you to new experiences and you do not want to miss these opportunities due to a lack of knowledge.
There are also a lot of networking opportunities associated with education, so you may also gain exposure to many people you may have never met otherwise.
If there has been a course you wanted, a seminar you’ve wanted to attend, or a certification you want to gain, this is the opportunity for you.
Continuing your education pays dividends not only financially, but also in your development as a more well-rounded individual.
Build up Your Emergency Fund
Your emergency fund is a building block of your personal finances. 99.9% of experts will tell you that it is necessary and for good reason.
Life can bring unexpected expenses your way and having an emergency fund is the best way to combat these expenses.
An emergency fund is typically a savings with 3-6 months of expenses. High-yield savings accounts are great places to store your emergency fund as you will receive a return on your money.
Some great options to try are:
- Marcus by Goldman Sachs
- Ally
- SoFi
DO NOT leave your emergency fund in your regular savings account. There are too many high-yield savings accounts with over 4% (as of January 2024) for you to settle for the 0.000000001% that you receive at your traditional bank.
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Having an emergency fund gives you options. You do not have to worry about what to do when you incur large expenses when you have an emergency fund.
Many people use their credit cards as their emergency fund, but this is not ideal because if your expenses outpace your payments, you are likely to max out your credit cards. There is nothing worse than having to pick through your credit cards to find where you have room to spend because they have been maxed out.
Credit cards are a tool that works toward your advantage only when they are paid in full, on time every month. The benefits dwindle drastically as soon as you begin to hold balances.
Save yourself the hassle of working through credit cards with your emergency fund.
Invest it
If you have money lying around and after you have maxed out your savings, investing could be a great option for you. Investing is a way to ensure that your money grows over time and that it is not sitting stagnant.
There are a variety of options that you can choose to invest your money in and they all have different advantages and disadvantages.
I prefer the more boring and consistent way of investing. I won’t tell you what to invest in; however, I have observed that if I stay the course and don’t touch my portfolio, it grows.
If you don’t have or aren’t willing to spend the time to really study your investments, you should probably go for a simpler approach. No matter what you choose, just know that there is always a certain risk involved with investing and you should act in a way that supports your risk tolerance.
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Build up Your Children’s Savings
Sadly, saving for children seems to get neglected in households that are not financially sound. Most people cashflow for their children’s expenses without really considering what the future may look like.
Using your tax refund to begin a savings fund for your children could pay you dividends in the future. Having some cash to give to your children once they reach a determined age can really give them the confidence they need to thrive in adulthood.
As someone whose parents did not save for my future, I know I would have really appreciated the effort of a parent considering my future.
Sometimes, it isn’t feasible for parents to save for their children, but it is something that you should really consider if you are raising children.
Contribute Towards Your Children’s Savings
Teaching personal finance skills to your children while they are young is extremely important. Giving your children the opportunity to encounter money and interact with it can lead to them having a better financial future than you had.
Creating a savings account for your children is a great way to use your tax refund. Your children can watch the money grow and learn to make balanced decisions regarding their finances.
Prioritizing finance with your children can give them valuable skills and help them avoid the same mistakes that you may have made with money when you were younger.
Time is on their side! Make sure that they use it!
Conclusion
Here are some great tips on how you can use your tax refund this year.
Paying off debt, building your savings, and investing in yourself are all great ways to use this extra cash. Whatever you choose to do this year, make intentional choices and take control of your money.
If you have any tips on what others should do with their tax refunds, leave it in the comments!