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You may have already or are due to receive a sizable tax refund in the mail and are unsure what the best course of action is to take with the money.
First, remember this money should have been yours all along, rather than giving a tax-free loan to Uncle Sam. Consider adjusting your tax withholding to increase your take-home pay.
Second, don’t get caught treating your refund check any differently than you’d treat your weekly or monthly paycheck. You’ll want to make it a priority to use it to get your finances back in order.
As you wrestle with competing desires to spend, save, or invest, here are a list of the best options to consider:
Pay Off High-Interest Debt
Eliminating debt such as credit cards, car loans, and high interest student loans should be the #1 priority.
If you have a lot of debt and decide to put your refund into savings, it is like borrowing from yourself.
However, using your tax refund to pay off debt is a very simple and valuable way of getting a guaranteed (18% to 20% earning on investments) return on your money. For example, putting down $1,000 against a credit card bill can be as good for you financially as a $1,000 investment that appreciates 10-29%.
Start with the debt that has highest rate and then work your way down. You can also try the snowball method, which involves attacking the debts in order from smallest to largest.
Ultimately, reducing or eliminating debt will help to raise your credit score and will also improve your monthly cash flow.
Boost or Start Your Emergency Fund
If you’re debt is under control, experts suggest to put your tax refund into an emergency fund.
This should have roughly 3-9 months worth of living expenses and be in an easily-accessible account that earns interest.
Having this emergency fund will increase your peace of mind. You will be able to pay out of pocket for any accidents, doctor visits, or any other unforeseen expenses, rather than charging more debt. Even adding a little bit to an interest-bearing savings account can help you out in an emergency.
If you have little or no debt and have enough savings, it it then recommended to invest your tax refund (especially towards your retirement).
My suggestion would be to start or contribute (if you have an existing account) to a Roth IRA.Consider this: if you deposit $2,000 in a Roth IRA at age 35 and average an 8% return, you would net $20,125 by age 65 without adding any additional money (wow!). As a bonus, you won’t get taxed on any investment gains and you can withdraw the sum of your contributions without tax or penalty.
If you’re under the age of 50, you can contribute up to roughly $5,000 this year ($6,000 for those over age 50).
Investment suggestions differ depending on your age/proximity to retirement, so please consult a professional for their advice.
Put It Towards College
It is never too early to start saving for your children’s college education. The costs of education continue to rise along with those with mountains of student loan debt.
A wise choice would be to start a 529 (college-investment plan) for your children or young relatives. This type of plan lets you save for your kids’ education expenses with untaxed dollars.
Make Home Improvements
Home improvement can be a costly venture, but you can make upgrading your home another investment in the future. Find ways to increase your home’s value (new roof, kitchen upgrades, appliances, landscaping, etc.), which in turn can amount to more money in your pocket when you’re ready to sell.